JasonC

U.S. Treasuries in a Bubble, Not Commodities

Problem - the premise is false. The Fed isn't pumping out money. The Fed's balance sheet is the same size as it was last October. All that happened in the meantime is the emergency short term loans to the banking system etc were repaid, and the Fed parked the proceeds in treasuries and agency mortgage backeds.

Everyone in the world is predicting the same US inflation and dollar collapse that was the bubble in the first place. It didn't happen 2005 to 2008 because the Fed held M1 completely constant over that span. It isn't going to happen this time either because the Fed hasn't moved its sheet size in a year.

The treasury auctions are 4 times oversubscribed in bills at zero and 2.5 times oversubscribed for the 10 years with actual yield.

Foreign investors did stop buying agencies over the last year but continue to buy treasuries hand over fist. China, Hong Kong, Japan, the UK, everybody else in smaller amounts. They may talk about the dollar being old hat but it continues to be the place they are parking their net new reserves. Foreign investors have also been buying the US stock market since April, at a $15 billion a month clip.

And the reason is clear - they are not willing to see their current account surpluses disappear, by actually pushing the US to trade balance. So the net capital inflow ot the US has slowed but it remains an inflow.

As for the much vaunted "carry trade", US investors owned less in foreign assets at the end of last year than nearly ever, really. Their foreign stocks got slammed; Americans don't buy foreign government bonds. Meanwhile the supposedly stupid US treasury positions all the foreigners have piled up earned plus 13% in that smash year. Foreign ownership of US assets went down because of the stock market decline, but only by $1 trillion, while US holdings abroad dropped $2.5 trillion - because we own their stock and they own our bonds.

As of the end of 2008, US investors had only a 5% position in foreign stocks and only 3% in foreign bond assets, and 80% of the latter are dollar denominated. The total US investor position in the BRICs is less than 0.5% of US household assets. Some carry trade. Nor can this change much net in the short run, because the net flow of capital remains inward at a $400 billion a year rate.

People talk their ideology but their actual trading positions are saying something quite different. Risk aversion is off the charts after last year's smash, and secular deleveraging continues.

Great Expectations for Obama, But Not the Markets

Um, what do you think all the ridiculous bubbles that just went smash were? They were bubbles in the real assets, money will go to zero, inflationary brainstorm trade. Everyone on the planet bet the moon that dollars would be worthless and real anything worth infinity. Guess what? They are all hopelessly wrong. So now when their trades all fail and they blow out, do they admit they were wrong about a particle of it? Why no, of course not. They think the world is wrong, but not them. They aren't in the most crowded trade in living memory, no siree, they are resolute contrarians, because they believed in every single 4-fold bubble and expect each one of them to magically reinflate to twice its previous maximum size.

Buy a clue already. Dollars are valuable and will remain so, they are not confetti, it matters what you pay for real assets, not that they are real assets rather than money. The insane attempt to profit by simply being in the right something without any regard to its actual price, is the problem, from the get-go. And until you all give up your inflationary "money isn't worth anything" brainstorm, you will be ground to powder.

Afterword, to be sure, there may be opportunities among all the busted bubble ideas. But they won't be merely the idea that the bubbles were all correct all along, and shouldn't have burst, and instead money just should have appeared out of the heavens until they were all correct, and the banks should just print enough to pay everyone on every bet they ever made - even when no one pays back those banks.

You will pay for capital or you won't have it. Banks will be profitable or you will get nothing and the price of everything will go down or sideways, never up. If a banker in New York can't get capital when he offers 10% for it, no one else on the planet will have any, either.

Wednesday Outlook: Commodities, Emerging Markets

No, inflation does not "no doubt" follow.
Everyone piled into the same bubble bet on inflation and got killed, and will continue to get killed.
All the inflationary bubbles go smash. Real estate, oil, BRICs, submerging markets, gold, all of them.

At these spreads, investment grade debt in the first world and especially in dollars is the best asset on the planet. Nominal claims, in the dollars you-lot have pretended are mere monopoly money, will trounce all your bubble blowing headline chasing scaremonger slander-games.

Watch.

The Credit Crunch Is the Solution, Not the Problem

Nonsense, the IMF has done the triage and the bad debts will amount to $2 trillion tops. A third of that has already been "eaten", another sixth was raised as private capital before the authorities intervened, and their intervention easily covers the rest. Also, the world economy is over $50 trillion a year, not $3 trillion. The total hit to the US came to only about 2% of household net worth from the bad debts alone. The bigger hit has been to stock prices and to present values by raising the rates on everything, due to higher perceived risk.

There is no way the scale of bad debts we have see sink anything but a few individual institutions. The silliness being peddled by the end of the world traders is just utter nonsense, they don't seem to have any idea what asset there are, who owns them, or any of it. All they can do instead of breathlessly repeat some notional value of unnetted derivatives - you know, the stuff that is supposed to kill us all tomorrow with the Lehman CDS's settle. Anybody think they are going to kill us tomorrow? Want a bridge?

The Credit Crunch Is the Solution, Not the Problem

I have looked at oil priced in Euros, and it was another typical bubble of tulip bulb proportions, completely unexplained by objective changes in either its own market or the value of dollars.

So were all the other commodity bubbles currently going splat all over the world.

The markets bet on a hyperinflation that never occurred.

The reason why it didn't occur is the Fed refused to play.

From the spring of 2005 to the spring of 2008, the Fed did not let M1 grow at all. That is the measure the Fed directly controls, because banks are legally required to have reserves only against their checkable deposits. CDs and savings accounts require *no* reserves at the Fed, and banks can extend or contract their issuance purely as savers are willing to accomodate them.

After the Fed took away the punch bowl, refusing to let M1 move, and raising rates, the banks continued to increase broad money to the tune of $2 trillion, and speculators betting on hyperinflation and against the dollar blew all their bubbles skyward with trend following abandon.

But it never had the slightest basis in reality. If M1 doesn't move, that new money cannot be spent. As soon as someone tries to move savings, net, to spendable forms and spend it, the banks need new reserves and must call in loans. In reality, though, very little movement or even pressure in that direct occurred.

All of the "inflation" was in asset markets, not in spending. No one was repudiating the currency, trying to reduce savings balances, trying to get rid of dollars as fast as they could, or any of the other signs of a fall in the objective exchange value of money. *Speculators* were *betting* that people would, but they flat didn't.

There being no extension of M1 to accomodate the assorted ballooning bubbles, none of the outsized price increases stuck. Real estate prices didn't stick, oil prices didn't stick, ags didn't stick, none of it stuck.

The banks' extension of $2 trillion in extra credit on the same, unmoving M1 base merely resulted in $1.4 trillion in loan losses practically immediately - and counting.

The Fed played it correctly. Arguably it was a year late and a bit slow in the rises around 2004, worst that can be said. But the banks, instead of retrenching as soon as the Fed signalled they ought to do so, with plenty of warning, instead binged and doubled up and bet on mega inflation and bubbles.

And they were comprehensively wrong. All the end of the world traders were wrong. All the commodity bulls were wrong. All of them were pretending that dollars and dollar denominate debts aren't worth anything, only "real" things are, that at *any* nominal price, anything real is worth more than dollar debts used to carry it.

And that was nonsense, all along. The debts were worth more than the bubbles blown on them. Everyone long the real and short the debts at the bubble tops has blown out. All the real assets belong to the lenders. Dollars are real, not fake. The Fed is responsible, not irresponsible.

And it was all nothing but guff and slander, from begining to end.

The Next Commodities Boom: Around the Corner?

All the king's horses and all the king's men
can't put this bubble back together again.

Will there be another round of a commodity boom? Sure. In 15 to 20 years...

Seven Reasons Inflation Won't Vanish

Weak take home pay in nominal terms is not what entrenched inflation looks like. Real entrenched inflation sees wages rise at double digit rates and barely keep up with prices even while doing so. There isn't the slightest sign of such wage inflation. And credit sources are systematically disappearing for already overextended consumers. As a result, there isn't the slightest chance that all these huge price increases will stick. Instead they will simply destroy demand, just as we saw with oil. It is a bubble. Everyone and his brother is predicting the same inflationary brainstorm, but someone forgot to tell the Fed, and M1 is not moving. Hasn't in 3 1/2 years. There are not more dollars chasing the same quantity of goods. There aren't any more dollars and they are doing less chasing, not more, as everyone hunkers down into cash investments. In a real inflation everyone is clamouring to get *out* of cash investments - there isn't the slightest sign of that.

The inflationary storyline is pure ideological drivel trying to wish itself into existence. It won't happen.

The Slow Start of Deflation: A Case for Bonds

The original writer is correct, bonds (not treasuries, corporates that actually have spread on them) will do quite well over the next 3-5 years. If you think treasury rates may move higher you can hedge part of the IR risk by being short T-note futures for about half the size of your long cash position in corporates. I would not try doing 1 to 1 as widening spreads can make the Ts outperform for short periods - but they aren't going to beat spreads this wide over the medium term.

Some of the financial preferreds are also interesting at these levels. You can get 8% on the soundest names, and 10% on moderate risk ones. The regional banks are up around 12% for credits that are objectively single A strength, which is an insane level of discrimination against the sector. If you have any fears about those, though, just use the better ones and settle for a 8-9% blended yield.

There are also a few floating rate preferreds which are interesting as a way to hedge interest rate risk, if you are unsure about the short rate outlook. Goldman preferreds can be bought today to yield over 6%, and will yield 140-150% of LIBOR if it rises, with a floor at the current rate. Those are a nice carry; the rate without any leverage isn't that interesting though.

For all of these ideas, sell if the spreads tighten up to 0.5% (or 0.75% more conservatively) again. Over a 3-5 year horizon that is likely - "this too shall pass". And it will involve double digit returns over that stretch, from the base rate plus the eventual re-tightening of spreads. With a lot lower risk than common stocks.

Self-Evident Commodity Truths

The average return of commodity indices over the past 20 years is only about 5% per year. Yes they are strong this year, while other asset classes that look good in a long rear view mirror did poorly (large cap value, commercial real estate e.g.). This is just the usual story of asset classes giving fairly random returns from year to year.

A modest weight in commodities can make sense, because they tend to zig when other assets zag. But hugely overweight positions in them are a Bad Idea. It is performance chasing and market timing at its worst.

In the long run, the reason commodities have punk returns is they produce no new income. Yes they benefit from large scale inflation. With sufficient lags, so do other assets - people won't lend forever at negative real rates - some with much lower risk. Also in the long run, real estate is at least as good an inflation hedge and actually produces significant current income, as well. It just got too overpriced recently, leading to a vogue for commodities as a replacement inflation hedge.

Do your homework on diversification and asset allocation models. Don't chase the last quarter's performance and expect it to continue forever. That's just a way to get fooled by randomness and pay extra for volatility instead of being paid to stand it.

Which Inflation Is It Anyway?

Ozzy - you do not appear to know anything about millenia of human history. In case everybody forgot, the reason "debasing" is called "debasing" is because governments readily inflated metallic currencies long before anyone dreamed of paper ones. The power of governments to act in short term or stupid ways isn't a function of the monetary system chosen, but of the specific policies of each government at each time. And you can't remove that power with an ideological line.

Second on the present financial situation, all it proves is that financial crises are normal. They can't be abolished and it is a mistake to try. You only destroy human freedom and the creation that precedes and follows the rearrangements required in the smashes. That there will be bubbles and crises and smashes, is an unavoidable consequence of human freedom, which includes the freedom to screw things up. Take away the freedom to screw things up and the government will screw them up for you, that is all.

Where there financial crises under metallic monetary systems? Of course. "But if you outlawed all forms of credit without 100% commodity cover, then..." then nothing. The value of the commodity cover fluctuates. The value is one thing and the commodity is another. The value refers to an entire state of the world and of expectations about future demand, which can always be falsified by sufficient forecast errors by entrepenuers.

Also, you can't abolish gratuitous credit without abolish most economic freedom. It was created by international merchants using bills of exchange, beyond the scope of governments - and it would be again. You'd have to chase everyone all over the world and jail them for issuing or accepting other men's IOUs. They always will, because sound IOUs work. They will always leave problems, because telling the sound from the unsound is hard.

There is no mythical way to wave away the possibility of financial crises. Everyone pointing at one and demanding that we give up another freedom is a snake oil salesman peddling a more intrusive government. Yes, I said a more intrusive government - there isn't anything libertarian about a particle of it. Free banking is a reasonable libertarian position. Making credit illegal is not.



asonC: hilarious. Millenia of human history mean nothing to you it seems - hold no lessons whatsoever. Fiat money throughout history has served as the vehicle of inflation to serve the purposes of the printers and those regimes have invariably collapsed under the weight of their paper money (but they had VERY flexible banking - right up until the end).

In truth, this has nothing to do with entrepreneurship. It has to do with the fundamental soundness of the monetary system. Have you looked around lately? It is precisely this soundness that is crumbling even as we speak - and for the reasons Simon and other cite, among others - hard to imagine how more blatantly obvious this could be. But let's not bother YOU with facts, either from the daily news, or from history. Facts are, after all, inconvenient things when they get in the way of 'flexible banking'.

Which Inflation Is It Anyway?

Bruno - no, banks issuing loans and others accepting their promises as money are not "government action". Banks were doing it themselves long before government had anything to do with it, and the Fed limits how much of it banks do. It does not create their ability to do so. Allowing a perfectly voluntary transaction to occur isn't government action, any more than not nuking New York City is government action. Moreover, merchants were doing the same before banks existed. Gratuitous credit is a creature of the freedom of merchants, not of government action.

Which Inflation Is It Anyway?

Simon S - I've heard the whole song and dance a million times from experts, it is still a total crock. You want gold store of value, buy gold already, nobody is stopping you. What you want instead is to have the gubmint run around stomping on everyone freely engaging in credit transactions on their own terms. I want flexible banks, not a gold straightjacket. No, you do not have any prior right to ongoing deflation enforced by jackbooted gubmint goons. If one entrepeneur wants to accept the mere promises of another, it neither picks you pocket nor breaks your nose. It is merely other men's freedom. And your wanting to abolish it because you think it inconveniences you is completely unjustified. Every time you spend a dollar on anything without my prior approval and at my direction, you bump around the exchange value of everything I could possibly own. But I don't object or call it stealing from me, because it is your freedom, not mine.

If you think bankers have it easy, join them. If you know they don't, stop slandering them. If you think fiat money stinks, get through the next ten years paying for everything in blueberry scones. You are benefitted by a perfectly functional transactions medium and freely use it. This isn't Zimbabwe, and pretending it is, is merely lying.

Also, in case nobody noticed, the Fed tightened over 3 years ago, and M1 (the measure it directly controls, limited by its own balance sheet size) hasn't moved an inch since then. The Pauleans are singing from an invariant script - don't bother them with the mere facts.

Which Inflation Is It Anyway?

Nonsense - the change in the exchange value of any asset due to economic activity by others is not "theft". Nobody guarantees the exchange value of anything will remain unchanged; nobody could, if anyone has the slightest economic freedom. You are responsible for picking your asset position, and you are responsible for the consequences in purchasing power over time. If you think banks have it easy under fiat money, buy bank stock instead of lending banks your deposits. Hint - they don't. Or use diversified portfolio investment or real assets as stores of value, not a transactions currency.

I insanely dislike this tendency to criminalize the side effects of other men's freedom. It is just a new version of the old hatred of capitalists and "usurers", and it leads directly to the destruction of liberty, economic first but not limited to that. Men are free to engage in credit transactions, including ones that expand money substitutes.

Every successful or unsuccessful entrepeneurial action on a sufficient scale, changes the exchange value of everyone else's holdings. Period. Financial actions are no different in that respect than big investments in this or that sector making assets within it more valuable compared to assets outside of it.