cameroni

Weekly Observations: Even with Government Intervention, Deflation Risks Continue

Nice article Tyler,

I too have an issue with your argument that too much capacity will rule out any inflation threat though. Because capacity is a supply side issue and reduced domestic supply itself plays into inflation scenarios in an environment of an expanding money supply I don't connect with your idea. I certainly agree though that we are in a deflationary death spiral at the moment. Certainly as far as Real Estate is concerned but I see the future more along the same lines as "Prudentinvestor".

I do not for a second underestimate that the Fed will succeed in re-inflating the economy, especially as it has expressly made clear we will have Quantitative Easing for as long as it takes to pull the economy out of it's deflationary trend. Those trillions will find they're way into the economy one way or another. How is not yet clear but my guess it will be under crisis circumstances and it will be big. Now I am not suggesting WW3 to pull us out of our spiral but any major event that spikes energy costs suddenly in an environment of squeezed supply (including under utilized capacity) will reinflate us quicker than you can say "Jack be Nimble". We really need to expect the unexpected and be ready for some serious dollar devaluation to acccompany a return to full employment. In relative terms we will all be poorer for it but we can hopefully stabilize and start getting back to business. I really can't see any of this happening though until we find a bottom in the real estate markets. And the sooner the better for all our sakes.

Cam

Unraveling the Housing Glut

I wish I could share your optimism of housing turnaround.

But I cannot. On the contrary I fully expect the current housing glut to increase over the next several years as house prices continue their slide. The largest factor affecting home sales now is confidence followed by some very dismal monthly employment numbers. Excessive debt levels, low savings rates and the prospect of interest rate hikes all weigh heavily on a continued slide south.

My biggest concern of course are interest rates. We do not need an economics degree to know that rates have only one way to go and that is up. Perhaps not this year but it will happen soon enough. Those tough enough to have survived a massive equity loss and who have continued to pay down their mortgage even when it exceeded the value of their primary investment will look seriously at capitulating as their payments begin to increase. Every point increase will drive foreclosures and bankruptcies higher and in the absence of full employment there will not be throngs of buyers willing to take up the slack of housing availability. Only vultures picking over the bones as they build rental empires.

These concerns though say nothing of the impending burden of increasing municipal taxes that are projected or being contemplated in order to maintain basic local services. All the current and reported job losses start to have more meaning when it is realized that the businesses that were footing a hefty part of the local tax bill don't exist anymore. Nothing could be more stark than a situation where the town's primary employer folds or the local mall is closed due to bankruptcy. Things that are happening across America now. I am not even trying to be pessimistic. I only need read the facts and monthly statistics to know the picture is dismal to declining. The naked facts tell us without a blush that this bursting bubble will not re-flate anytime soon.

So I see quite a different picture emerging from the scenario you presented and that is one where larger numbers of people will co-reside in existing homes. They will cut their costs by sharing. Children will not leave home so readily, Seniors will attempt to unload their homes to help save the kids and then move in with them and almost everyone under pressure will start renting out the spare room or the basement to tenants. We have never been good at sharing space in this country but that is changing. The change is being brought on in part by the tidal wave of debt in the big picture but more so by small changes in our daily lives that our affecting our ability to carry on with life as we have always known it. We are creatures of habit and comforts. Spoiled by easy access to all our wants and needs. The economy may be in decline but we won't be cheated so easily without a fight. Even if surviving and getting ahead suddenly means sharing space. We'll do that well and still make the car payments. We may even have bragging rights to this strategy.

Failures in the economy, fears, real and potential job losses, and the evaporation of nest eggs to dysfunctional market forces are all adding up to sustain real estate devaluations for some time to come. Home sales by and large will languish for many years as we adapt to changes in the economy and learn to live with one another again. But it's a good thing too. I welcome the "new" nuclear family with three generations in one home, a renewed respect and conservatism that is only learned by those living closer together and a rebirth of cooperation.

I would sum up by saying, there is strength in numbers and the real estate bottom is not in yet. Not even close.

Cam

The False (Chinese Driven) Rally in Copper

Look, China is buying up metals opportunistically at a good price. It does not matter that they don't currently need them. What is important from their standpoint is that they they convert some of their foreign dollar holdings (US Dollars being only one source) into something of value.

Cash after all is only intended to be a short term means of holding liquid wealth. To attain value it needs to be spent and to hold value it needs to be spent on strategic or useful commodities. Everyone wonders when China will begin to divulge itself of it's US Dollar holdings and begin to buy gold. This is simply not about to happen anytime soon. When the Chinese start to buy Gold in a significant way the value of the dollar will already be in a steep descent. To do so earlier is to shoot themselves in the foot. It would be an act of economic stupidity. It won't happen.

Gold is so politicized that any large scale purchases by the Chinese will invite an almost immediate backlash against US Dollars, The Chinese have a big investment in the dollar staying strong. Think as a chessman for a moment. What would you buy to preserve the value of your foreign reserves while shifting some of the burden of those reserves to others? Commodities of course but not precious metals. What metals won't invite close scrutiny? What will gain in value over the long term and what has considerable value both in times of war and peace? Copper of course is an excellent choice. It is one in a basket of buying options that when bought in volume will not alarm global markets. It can also be traded as readily as precious metals at any time in the future or simply retained as insurance against a dollar-bust.

So I think it is important to consider that China is not behaving like a typical investor but is acting in a way that considers all the political ramifications as it begins to shift it's foreign currency reserves into hard assets of real value. Anything will do. Gold and Silver are taboo though because the message is just too strong. This is to say that what inflationist's and many economists fear most, that China will divest itself of US dollars in order to protect it's investments is actually coming true. It is coming true through the back door though as Asia shifts dollars into third world economies and buys up heavily discounted commodities that it will eventually use or trade anyway. It is an excellent strategy for them because they do not need to hide the acquisitions nor their stockpiling. This does not bode well for the dollar and is in fact a huge signal that China's central planners are anticipating serious dollar devaluation. I think the writing is on the wall here if you can understand the concerns coming from Asia about protecting their investments in turbulent times.

Cam

Wall of Worry over Rally Begins to Tower

Well I do agree with you William,

There is a bit of game playing taking place with Tarp money, earnings reports and market expectations as the Financials are concerned. What I see is a very good opportunity to short them in the very near future. There is not even a debate in my mind that the Dow is set for another tumble. The failure of GM and Chrysler this quarter (million plus jobs on the line) could certainly trigger a major event but there are so many other bad news stories that collectively tied together this month will see us heading into another downward correction. The current bouyancy in the markets is based more on hope and habit than real optimism and faith of a turnaround. Virtually all indicators continue their down-trends with only opportunistic investing on global stock markets showing signs of life. You would be a fool to go long on anything now. We are in fact at or near a turning point and the markets can be expected to begin another decline. How severe will really all depend on the bad news we already expect (employment numbers, inflation changes, GDP, housing starts, bankruptcies etc) and the bad news we do not expect. The odds favor the bigger trend now though. I would not rule out a precipitous and sudden decline at this stage and frankly it would not take much of a sell-off to start a cascading event that will bring markets back into sync with what is actually taking place. We are overvalued again relative to the greater economy. A correction is imminent.

Cam

Obama Just Pulled a 'Reagan' on the Automakers

It's a shame really.

So many thousands of jobs both directly and indirectly will be affected by a failure of the automakers. And yet chapter 11 and a major restructuring is really the only solution especially as unions have started to dig in their heals and management behaves as though we are still in a good economy. That lack of flexibility alone would signal the end of these companies at this juncture. We are in a deflating economy. It is a good and necessary event. Long overdue too. What goes up must come down. In this case that means wages at all stages of the supply chain.

Tata of India has recently announced a new car that will cost only about 2000 dollars stripped down. We live in a global world and our Auto makers have not caught on that we need to start to compete against countries where wage earners overseas do not get in a day what our UAW and CAW earn in an hour (much less than that actually). And while I am not suggesting that GM or Chrysler pay their workers a dollar an hour I am saying that there are a lot of hungry people out there who will happily get the job done for a fraction of current pay levels. And it is no idle thinking to suggest that all of the Big 3 may eventually have to migrate operations overseas or to Mexico to survive.

So send them into Chapter 11. Cancel the collective agreements, extinguish the pension liabilities, end the debates and arguments and bitching and recriminations. Start fresh. The current course of action simply cannot continue without the eventual and complete failure of all three North American car manufacturers. And the numbers show it is just a matter of time.

It may be difficult but we are going through a period of global income re-balancing. That means fewer real dollars here at home and more in the pockets of people and business in developing countries. Even Africa, the worlds economic basket-case is finally starting to get in the action. Ethiopia of all places was predicting growth above 9% for the most recent fiscal year as manufacturers from China moved textile and other manufacturing operations there. Why? Cheap labor of course. Cheaper than Asian labor by a long shot. Yes,..even Chinese companies are seeking lower cost jurisdictions in which to manufacture goods and countries where environmental standards and labor regulations are low to nonexistent. Places that used to look risky for business are suddenly appealing because there is a global blind-spot to these regions and some of the more distasteful business practices can be carried on without oversight. And my God, what person in their right mind would deny Ethiopia jobs and incomes anyway!

So what do Africa and India and China have to do with North American auto manufacturing? Everything of course. My answer to that question is this. If these companies cannot resolve their cost structures and business models to become competitive globally then they will become extinct or their surviving operations will be forced to shift operations abroad and into competition with the real world. The very future of GM and Chrysler now depends on a planned and strategic bankruptcy and restructuring.

Bailouts will not save them.

Cam

Sucker's Rally: Stop Calling the Bottom

Interesting article,

And I am mostly in agreement with you Lee. The bottom has not been reached by a long shot despite some good noble attempts to re-flate the economy. Some very difficult days lie ahead. The bulls cannot snap out of their pattern of belief in a continually rising market. Nor the fear that they may have missed the market bottom and a lot of profits. They have not yet accepted that the big trend is down and some painful adjustments lie ahead. Hope lies eternal. This is bear season though and the biggest money of the century is all in shorts.

We are due to go through a major structural change in North America in the coming months and years and there will be a lot of broken dreams along this road. Inflation is only one of the threats we face along this path. There is another though that is frankly a much greater danger to the average debtor and home-owner than any other issue to date. It will be personal. It will affect every debtor in America. And it will devastate the survivors of this current asset destruction phase. That looming threat is high interest rates and the trend has already begun. And if you doubt that, then just ask yourself this..."If historical interest rates are at a bottom right now, then where do they have to go but up?"

But that of course is not a rationalization for higher interest rates. Higher rates are a function of the market, the global economy, demand for capital and risk. And contrary to popular belief the government is not in control of these rates. They will be set by market forces outside our borders.

Inflation meanwhile is almost certainly in the cards now and this point was made lucidly clear with the recent debt monetization. The money presses will roll and all attempts will be made to inflate our way out of the mess we are in. Inflation (possibly hyperinflation) as an alternative to a devastating deflationary depression seems OK on the surface but it will actually lead to more wealth destruction than any depression could have achieved. Sometimes it is better to fight the devil you know than the one you don't. So watch closely because the "interest rate" genie will soon be out of the bottle. And that monster will bring a whole new round of business failures and bankruptcies
that will make the current difficult situation look quite tame.

And how damaging will it be? You don't need to look beyond the early 1980's to understand how double digit interest rates damaged the economy and stifled business investment. This is not to mention how home prices were very negatively affected and real fear ruled the markets. But housing prices are already being crushed you will answer. It can't get worse. Or can it?

Sorry. It will get worse. A lot worse too. The housing bubble has burst and market balance will not be restored until it has completely deflated.

Consider that for most people, the interest paid on their mortgage is the largest part of each monthly payment. Principle payments each month are relatively small. If you double interest rates then you effectively double monthly payments. But what if they treble or quadruple. How many home-owners currently underwater on their mortgages will survive even a doubling of their current monthly payments.?

That is the future though and there is not enough bailout money in the global treasury to backstop this disaster. This freight train cannot be derailed. And I sincerely wish I could say that I was making this all up. But I lived through the high-inflation and high-interest rate days in the early 1980's. They were brutal and devastating but this is really much worse because this time we will (economically speaking) be entering into the same situation in a more financially weakened state.

How can you protect yourself?

You should consider that we currently have some of the lowest interest rates in history. You should, if you have a mortgage, think of taking a long term view of the risks ahead. Would you take a one year term-mortgage at 6% in this environment if you knew that on renewal you were going to be faced with 12% at this time next year?

Think about it.

Even if you keep your job and remain solvent, an interest rate spike that doubles your monthly payments could still wipe you out and force you into bankruptcy. And you will lose your home too.

This is a real risk that all debtors need to consider seriously when renewing lines of credit, mortgages and other long-term debt.

I would be happy to hear comments from anyone on this topic because it is simply not being discussed anywhere at the moment and yet it is one of the biggest risks we have going forward.

Cameron

The New Unwind

If there was ever a good time to be a consumer, that time is now.

Long after boxing day the "Boxing Day type' sales flyers keep coming to my door. When I see quality products offered at 70, 80 an even 90 percent off the regular retail prices I get interested. Now is the time to consume. But that consumption should be done in a strategic way with a long-term view in mind. For any of you who believe that we have serious inflation in the future you should consider stocking up on those goods, particularly imported, that are available now at fire-sale prices.

Remember the maxim, "buy low, sell high". Now ask yourself why it makes sense to buy products at full cost like there is no tomorrow, yet shun the greatest bargains we have witnessed in a decade. Some of the best deals I have seen in my life in fact are happening right now.

These are indeed the good old days. We will look back on this time and wonder what we were thinking by not shopping when the best of all goods were priced for quick liquidation.

There is a bigger concern though, and for those of you who follow international trade, read the Baltic Index and are aware of widespread manufacturing closures overseas, shipping and trade fall-backs you will sense the urgency of my next remarks. Global Goods Supply is drying up rapidly. Simultaneously, we are witnessing massive infusions of new money into the system. M1 growth is staggering but it is only a snapshot of what is actually a bigger picture. A similar expansion of the money supply is taking place in concert all over the globe. Indeed, most of Europe is in an eerily familiar currency expansion phase. This means inflation is in the future in a very big way. And staggering interest rates will only follow in due course.

But the point I am trying to make is this.

In an environment where the supply of goods is rapidly diminishing due to economic circumstances and while the the Money Supply is rapidly increasing to cure that economic problem, the only outcome can be rapid inflation. Brutal inflation. Double digits. God forbid not more.

So to return to my original idea. This is a very good time to buy consumer goods. Buy the bargains and the sales. Buy the things you need or those things you can use as trade-goods in the future. We are at or near the maximum buying power of our dollar and have not had this opportunity in decades. Nor will we see it again soon. Currently, prices of manufactured goods are down significantly, even to historical lows, while the dollar is up (and increasing in value relative to the Euro and most other currencies). So take your appreciating dollars and buy the best sales bargains you can get.

Stock up on extra things too. I can assure you that shopping in the future will be something you will avoid like the plague as prices spiral out of control and the dollar simultaneously tanks.

Think it through. Then go shopping! And have a great year!

Cam

Do Not Trust This Market

Nice article Kip.

I could not agree more with your assessment that the Dow will see 5000 on this cycle. It is a breath of fresh air to see someone with credentials talk about the future and put gutsy estimates to it. I am reassured though that there are a lot of others who feel the same but just don't want to risk their reputation on a call like that. So kudos to you. I am frankly looking for gold to buy the Dow at the 3800 mark, which makes me a pessimist of the extreme but I have confidence and I think time will show this was a fair call.

Cam

Silver and Gold: More Than Just A Christmas Carol

You are laughing now Gold Barron but one day in the future you might wish you had listened to some of the others here. Of course Gold could rise to 5 or 6 thousand dollars. It is precisely because it is priced in US dollars that will be possible. But you need to believe and subscribe to the inflation worries of the folks who are actually paying attention first. Owning 5000 dollar gold may not make your real-world buying power that much greater but your wealth won't have been inflated away to zip either.

Actually your real-world buying power should increase given that gold demand will badly outstrip supply worldwide. The whole globe is invested in US dollars at the moment and a major sell-off will badly affect America when that time comes. I personally think it will begin rather slowly over a period of a couple years and then turn into an avalanche of greenback sell-offs at which point any physical gold you own will be seized by the government. But that's just me speculating on a worst case scenario..

Right now the Chinese are doing trials with the Yuan in HongKong and Macao in preparation to make the Yuan an international currency. As part of those preparations they have suggested they will purchase up to 4000 tons of gold. That's a lot of gold but it is still not as much as is held by the US. In the meantime they have sent their first ever warship abroad and towards the Red Sea and the Horn of Africa, ostensibly to guard against piracy from Somalia. In the background there is the ominous concern of a Chinese led sell-off of some of the 2 trillion dollars in US foreign currency reserves they hold. Some 100 billion or more of those dollars will be used to purchase gold. Now start connecting the dots.

The big gold buy is a strategy to hedge against dollar devaluation,and to position China globally as a major player. Establishing the Yuan as an international currency could allow them to dominate Asia altogether. Defining a clear, albeit small, military presence in a region critical to American interests just makes plain good sense from a strategic point of view. Especially if the worlds dominant player is weakening. I do not believe any of this would likely be taking place if the Greenback was not at risk of serious devaluation. And of course dollar devaluation will drive gold prices up.

Perhaps the 400 ton gold purchase is worth as much as a 25% hedge against current US foreign currency reserves (500 billion x 4) which might suggest gold at 5 times it's current value priced in US dollars. That is, in the event of serious inflation, they would not take a bath. I don't see a five time factor as being out of the question at all.

It doesn't hurt to try to draw some conclusions from what is happening in Asia. So you have to ask yourself how ridiculous it is to consider how a major run-up in inflation, partially brought on by a dollar sell-off might easily see Gold in the 5 or 6 thousand dollar range.

Just my opinion.

Inflation Is in Our Future...Not Deflation

I tend to agree with the premise of future inflation and high gold prices but not in the way the writer has suggested. There is simply not enough gold for us to be using it as a means to balance international trade anymore. I would tend to think that other large scale commodity trades will be the wave of the future to settle claims between countries if currencies are failing. Gold will benefit of course but not as a re-invented currency in itself.

Inflation is a near certainty in my opinion. it is easy to see the logic in it's necessity (yes, necessity) if we stop reading into the daily micro-analysis in the papers that leads to total investor confusion about our future.

The basic problem is that US debt levels are simply too high and in fact beyond the point of being paid back. This becomes especially true in times like these as GDP declines, unemployment rises and the Government compromises itself by being forced into reducing taxation in order to stimulate the economy.

The US simply cannot go bankrupt, neither can it pay back all the money it has borrowed and is continuing to borrow. Inflation must be and will be the answer to this dillema. We will only be able to pay down our debts by a massive expansion of the money supply and the inflation that results from this move. Inflation is our salvation in one sense but it will create a great deal of domestic and international pain in the process. There really is no other alternative because the structural pains that result from a depression will not get us out of the hole we are in debt-wise.

In any case, high levels of inflation are a defacto bankruptcy as it allows us to repay our debts with smaller and smaller dollars. But this medicine won't be delivered to the lenders in a wrapping with that tag attached. The worlds financial system will have to eat this one to remain functional and that is why it will be accepted overseas. High levels of inflation are the only real way we can continue to function while we meet our international obligations.

So we need inflation and therefore we will have it. The Fed is driving that point home through massive spending and borrowing that is simply unprecedented. The writing is on the wall. So, yes I do agree there will be inflation despite current deflationary signposts that are distracting us all from the big picture view. The deflation alternative is so ugly and involves so much wealth destruction it cannot be allowed to happen. And it will not happen with the cooperation of our trading partners.

So I favor holding positions in gold and silver and other commodities as a basic insurance policy. It is foolhardy to totally disregard this writers ideas even if they don't all make sense. The outcome will very likely follow his prediction of higher gold prices going forward.

I don't incidentally think that China's plan to buy 4000 tons of gold is any coincidence in light of the big picture trends.