Deflation Risk Dipping As Stagflation Risk Rises

Includes: GLD, SLV, TBT, TLT
by: Gregor Macdonald

Raise your hand. Did you purchase the 30 Year US Treasury Bond at the 27-year high of $142.66, in December 2008? Because you’re not just making a single bet you can ride senior sovereign debt into the mouth of deflation. You’re making an additional bet that the private banking system can detonate and collapse while at the same time Washington can continue to service its debt, as tax revenues virtually disappear. Or perhaps you’re making a third bet, that the US is so exceptional future purchasers of US Treasuries will be happy to know that all new auctions will be monetized. Regardless of your thinking, I see US Treasuries as having too many ways to lose, and only a few ways to win.

In the January edition of my monthly newsletter Saving Hugh Hendry (download sample) (.pdf), I suggest Treasuries are at an historic turning point: To boot, the situation with sovereign debt has now finally exploded onto the front page, courtesy of the UK.

Keith Moon, The Who, London BBC 1973 by Michael Putland

Although I go into further detail in the newsletter, it’s frankly very easy to explain what’s happened in the UK, and how it previews what’s nascent in the US. Essentially, the UK banking system is insolvent. Thus, the BOE and the Government have taken too many liabilities from that system on to their own balance sheet. Eventually, the market realized that the weight of these liabilities were significant in relation to the size of the UK economy, especially as it entered recession. Thus, global markets began to sell off the British pound further, and, despite a forecast of deflation sold off UK Gilts.

That’s how reflation starts. Oh, don’t misunderstand me. I’m not suggesting that a positive or helpful reflation is now due for the UK. On the contrary, what appear to be coming for the UK is a continued deflation in housing and credit markets and yet very likely a big slowdown in any fall in energy, food, or goods prices. This is exactly what’s in store for the United States. All of the conditions present in the UK, are equally present in the US. To those who falsely believe we are protected in the US because all our Treasury debt is USD denominated and we can simply print up USD I say this: please listen closely to what you, yourself, are saying.

Because there has indeed been such a rout in UK Gilts, and because US longer-dated Treasuries looked to have peaked in December, and because Gold and Silver are back on the march, I am raising my Stagflation forecast as a competitive risk probability now, to outright Deflation.

Photo: Keith Moon, London 1973