The short-squeeze mania that sent stocks blithely higher yesterday reminded us that shares are likely to remain erratically buoyant at least until the end of the second quarter. “Rebalancing” has been the name of the game since the bear rally began in early March, and portfolio managers are unlikely to alter their allocation strategy with less than a week to go before they get their final “grades” for the quarter. Meanwhile, if there was any doubt about the aggressive institutional tilt toward shares during Q2, they were refuted by a friend of ours who recently moved his wealth management business from one brokerage house to another after being a star at the former for more than 30 years.
Our friend has done extremely well for his clients over the long haul, mainly by being in and out of stocks at the right time. (For the record, he just bought U.S. zero-coupon STRIPS of 2037 for his own portfolio.) In recent months he had his clients more heavily in fixed-incomes than his employer would have preferred. They put the screws to him, insisting that he boost his clients’ portfolios to 75% equities, and that’s when he decided to bolt. One might have thought they’d cut him some slack, since he has consistently ranked among the very top brokers in the U.S. But the company’s “culture” has changed radically under new management, and many of his colleagues, including the top brass, have abandoned ship. We’d love to short the stock of this company, except that it is no longer publically traded, having been absorbed by a giant of the banking industry whose name will go unmentioned.
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Regarding the ongoing, though presumably doomed, resurgence of shares, it wouldn’t take much for DaBoyz to tighten their grip on the scrota of bears, sending stocks into a parabola to end the quarter. To accomplish this, for starters, we require that a “booster stage” rally exceed at least two prior peaks on the hourly chart. Yesterday’s surge, fierce though it may have seemed, did not surpass even a single such peak. However, as the chart above shows, it left the S&P futures in position to knock off both of the required peaks with a further thrust above yesterday’s highs of just 7.25 points. Shorts looking for respite in the form of a pullback may get just the opposite: a squeeze overnight that pushes the futures past one or even both of the peaks before Friday’s opening bell. If that should occur, prepare to be inundated over the weekend with headlines about how the stock market is leading the U.S. out of recession. Far more likely, in our opinion, is that the stock market is leading us to the edge of a towering cliff.
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Alleged Inflation vs. Deflation
We’ve insisted all along that anyone taking the inflation side of the alleged inflation vs. deflation “debate” was unclear on the concept. The whack-jobs in the inflation camp seem to think its all about the money supply, but we suggest using a much simpler metric, to wit: As long as the real burden of debt, both private and public, is increasing, deflation rules. But if you need more proof that inflation is just a hallucination at the moment, here’s a link to a guy who gets it – Dr. Housing Bubble.
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{ 6 comments }
Rick,
without taking sides in the d vs. i thing (or maybe I am), I think that saying:
“…The **whack-jobs** in the inflation camp seem to think its all about the money supply”
is not the right description. After all, I don’t think one should call von Mises, von Hayek, or Rothbard whack-jobs, but they surely said this.
So did Friedman, in a way, so you are not perhaps entirely unjustified when using whack-job.
A question, would you consider Exter to be a deflationist, and his thougts to fit better?
If so, while most of the layers at the top implode (deflate), their remains crashi into and pile up further down, crowding them bigger (inflating).
The end result would be a deflation in 90+ percent of things (paper assets of all stripes, illiquid real assets such as residential and commercial real estate, etc.), but not in the strongest remaining rest, the liquid one, where of course we find Au and Ag…
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Rothbard, Hayek et al. may never have pondered the paradox of deflation in a fiat-money world, since it was well nigh beyond imagining that financial leverage would one day aggregate into the hundreds of trillions of dollars. But that is what happened, and no amount of printing press money short of hyperinflationary quanitities can reverse the black-hole power of the deleveraging now under way. RA
Here are some thought regarding inflation vs. deflation from Jesse. (Unfortunately the charts did not load, but if you go to the following site you can read the article with the charts.)
http://jessescrossroadscafe.blogspot.com
In the Inflation Camp
To many people, a deteriorating economy, sluggish bank lending, and widespread frugality indicate that deflation is by far the biggest threat we face. But as Jesse’s Café Américain argues in “Some Common Fallacies About Inflation and Deflation: the Weimar Nightmare in Review,” history suggests that might not be the case.
There are several fallacies making the rounds of the economic community, often put forward by pundits on the infomercials for corporate America, and also on the internet among well-meaning but badly informed bloggers.
The first of these monetary fallacies is that ‘the output gap will prevent inflation.’ The second is that a lack of net bank lending or other ‘debt destruction’ will require a deflationary outcome. Let’s deal with the output gap theory first.
Output gap is the economic measure of the difference between the actual output of an economy and the output it could achieve when it is most efficient, or at full capacity.
The theory is that when GDP underperforms its potential, with unemployment remaining high, there can be no inflation because demand is weak and median wages will be presumably stagnant. This idea comes from neoliberal monetarist economics, and a misunderstanding of the inflationary experience of the 1970s.
The thought is that sustained inflation is due to a ‘wage-price’ spiral. Higher wages amongst workers cause prices to rise, prompting workers to demand higher wages, thereby fueling inflation. If workers do not have the ability to demand higher wages there can be no inflation.
While this is in part true, it tends to confuse cause and effect.
The cause of a monetary inflation, which is a broadly based inflation across most products and services relatively independent of demand, is often based in a monetary expansion of the currency resulting in a debasement and devaluation.
A monetary expansion is relatively difficult to achieve under an external standard since it must be overt and often deliberative. A gradual inflation is an almost natural outcome under a fiat currency regime because policy-makers can almost never resist the temptation of cheap growth and the personal enrichment that comes with it.
There can be short term non-monetary inflation-deflation cycles that tend to be more product specific in a market that is not under government price controls. But this is not the same as a broad monetary inflation or deflation.
The key difference is the value of the dollar which has little or nothing to do with a business cycle or product demand/supply induced inflation/deflation.
In the modern era the Federal Reserve can increase the money supply independent of demand by the monetization of debt, with the only restrictions on their ability to increase supply being the value of the dollar and the acceptability of US sovereign debt. This requires the acquiescence of the Treasury and the cooperation of at least one major money center bank.
People tend to invent ‘rules’ about how the money supply is able to increase, and confuse financial wagers and credit with money. This is in part because the average mind rebels at the reality behind modern currency and the ease at which it can be created. Further, people often invent facts to support theories that they embrace in an a priori manner.
In a pure fiat currency regime, the swings between inflation and deflation are almost always the result of policy decisions, with the occasional exogenous shock. A government decides to inflate or strengthen their money supply relative to productivity as a policy decision regarding spending, central bank credit expansions, banking requirements and regulations, among other things.
As a prime example of a rapid inflation despite a severe economic slump, what one might call uber-stagflation, is the Weimar experience.
Since pictures are worth 1000 words, let me be brief by showing you a few important charts.
The basic ingredients of the Weimar experience are…
A high level of official debt issuance relative to economic growth
High unemployment with a slumping real GDP
Wage Stagnation
I should stop here and note that although the statistics at hand involve union workers, in fact unemployment was widespread in the Weimar economy. The saving grace of being in the union was that one was more often able to retain their jobs and some level of nominal wage increases.
Anyone who has read the history of the times knows that unemployment, underemployment and slack demand was rampant, and that hoarding was commonplace as people refused to trade real goods for a rapidly devaluing currency.
Rapidly Rising Prices Despite Slack Demand and High Unemployment
So much for the wage price spiral and the output gap.
A Booming Stock Market, at Least in Nominal Terms
Booming Price of Precious Metals as a Safe Haven Even While Basic Material Prices Slumped
Notice the plunge in the price of copper as the economy collapsed and gold and silver soared.
If one can obtain a copy, as it is out of print, one of the best descriptions of the German inflation experience is When Money Dies: the Nightmare of the Weimar Collapse by Adam Fergusson. There is a copy of the book available online for free here.
From my own readings in this area, the people who tended to survive the Weimar stagflation the best were those who:
1. Owned independent supplies of essentials including food and shelter and were reasonably self-sufficient.
2. Had savings in foreign currencies that were backed by gold such as the US dollar and the Swiss Franc
3. Possessed precious metals
4. Belonged to a trade union and/or had essential skills or government position which guaranteed a wage
5. Were invested in foreign equity markets, and even in the domestic German stock market for a time
People will argue now that the Fed understands that inflation is caused by perceptions, and that by managing those perceptions inflation can be avoided because even those prices are rising and the currency is being devalued, if they ignore it the inflation cannot reach harmful levels.
This is what I call the “psychosis school” of behavioral economics.
Granted, perception is important, and managing perception may delay outcomes for a period of time. But unless the underlying cause of the problem is remedied during what is at best is an extended interlude, the resulting break in perception will ignite a firestorm of cognitive dissonance, loss of confidence, and social unrest.
In summary, in a purely fiat currency regime a sustained monetary inflation or deflation is an outcome of policy decisions regarding fiscal policy, monetary policy, and economic balance and output.
As long as the government is able to generate debt, deflation is a highly unlikely outcome. And when the government reaches the practical limits of debt creation, the underpinnings of the currency give way and the economy tends to collapse in a stagflationary slump.
There are no predetermined outcomes in a fiat monetary regime. Deflation, stagflation and hyperinflation are not ‘normal’ but are certainly possible if the central authority is permitted to abuse the real economy and the money supply for protracted periods of time.
What about Japan? Japan is the perfect example of a policy decision made by a fiat currency regime in what was decidedly NOT a free market, but under the de facto control of a highly entrenched bureaucracy, a single political party, and large corporate giants in pursuit of an industrial policy that favored exports and domestic deflation.
The difference between the Japan of the 1980s and the US of today could not be more stark. Choosing a deflationary policy and high interest rates as a debtor nation is economic and political suicide. It would be interesting to see what happens if the US elites try to take that path.
We will know if there is a true monetary deflation in the US because the value of the dollar will start increasing dramatically with regard to other hard assets, other currencies, goods and services, and precious metals and commodities. Prices will decline especially for imports as the dollar gains in purchasing power.
Remember that a true monetary inflation and deflation would only show up over time. Even in the Great Depression in the US, as demand slumped and prices fell, the stage was set for a significant devaluation of the US dollar and a rise in consumer prices well in advance of the eventual recovery of the economy that caused the Fed to tighten prematurely. As I recall the actual contraction in money supply lasted two years. This again highlights was an amazing piece of bad policy that Japan represents in its ‘lost decade.’
People embrace beliefs for many motivations. So often I find they are not ‘rational’ and based on a scientific study of the facts, even on the most cursory level. Fear and greed and prejudice are often motivations that are surprisingly resilient, even in the face of overwhelming evidence against them. Leadership understands this well.
There are often appeals to private judgement. I do not care what you say, this is what I believe, what I think, what I feel. This is appropriate in the supra-natural realm, but in the natural realm there may be private judgement but the facts are public, and the outcomes are well beyond the complete control of the most fully-managed perceptual campaigns, at least so far in human experience.
“The lie can be maintained only for such time as the State can shield the people from the political, economic and or military consequences of the lie. It thus becomes vitally important for the State to use all of its powers to repress dissent, for the truth is the mortal enemy of the lie, and thus by extension, the truth is the greatest enemy of the State.” Joseph Goebbels, of the perception modification school of economic thought
What is truth? It is difficult to estimate but not completely out of reach.
Our own view is that a serious stagflation with further devaluation of the US dollar as it is replaced as the world’s reserve currency is very likely, after a period of slackening demand and high unemployment. A military conflict is also a probable outcome as countries often go to war when they fail at peace.
Weimar was not an anomaly although the level of inflation was indeed legendary. Argentina, post Soviet Russia, and most recently Zimbabwe are all similar examples. Serious Instances of Monetary Inflation Since World War II
There are many, many variables in play here, and policy decisions yet to be made. It is highly discouraging to see Obama’s Administration fail so miserably to do the right things, but there is always room for hope, less so today than six months ago however.
Argue and shout grave oaths and wave our hands though we might, we are in God’s hands now.
Let’s see what happens.
A very special thanks to our friend Bart at Now and Futures who makes these charts, among other things, available on his highly informative web site for public review. If you are not familiar with his work you might do well to view it. We do not always agree, but he demands attention because of the rigor which he applies to his work for which we are grateful, always.
As far as my two cents goes, one could easily argue that the dollar’s long-standing role as a reserve currency means that there are a great many “unnatural” holders of the U.S. currency around the globe. Generally speaking, they require more incentives than Americans to remain invested. In a world where the U.S. is no longer seen as the leader it once was, where the risks stemming from hyper-expansive fiscal and monetary policies are increasingly apparent and growing by the day, and where many old truths are no longer being taken for granted, it is not a stretch to think that today’s demand for the currency could easily evolve into tomorrow’s rapidly growing supply.
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If you search a million web pages on the topic of the Weimar hyperinflation, you won’t find a word about how that printing press money got into circulation. My guess is that it was shipped out daily to major employers.
When I receive from Bernanke my UPS box filled with $100,000 Federal Reserve Notes, then I’ll start listening to the inflatonary camp. Until then, I’d prefer to trust my own observations. RA
That was a long comment. Sorry I didn’t read the whole thing but I got the big picture. Any government always and everywhere has the power to break deflation like a dry twig. The question is does it have the willpower to do it? My answer is probably not. I’m not going to get a check for $100,000 in the mail. “Ain’t gonna happen” as they say.
I believe there will be both inflation and deflation happening at the same time. Domestically we will be deflation. Housing, cars, vacations ect will deflate will cash being in high demand. Internationally the dollar will most likely be weak. Some commodities will soar. Gold and food come to mind.
Also, I’m not quick to be bearish on the stock market here. It’s way too obvious for a large downturn here. I think we could rally all the way to 12,000 or more. That would crush the bears just in time for the bulls to take a beating again. The stock market still has legs even if the economy sticks. Don’t underestimate it.
Rick, if some eighty years ago the authorities found quaint ways to get money into the hands of the populace, then they surely can do it today. And they will be able to do so far more efficiently given the state of technology today versus Germany circa the nineteen twenties.
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It’s not finding a way, it’s finding the will. When three zeroes are appended to my checking account balance, I’ll believe (hyper)inflation is here. Until then, mere inflation — which is what mere fiscal stimulus would attempting to create — will have zero effect on a deflationary juggernaut that is drawing it power from the collapse of a global financial edifice whose notional value may have exceeded $500 trillion at its peak. RA
Well the goverment gives you a full year unemployment… 15,000 to buy a house (when that bill passes), 5,000 to buy a car… Another $250 check if you are old….. They are going to let you refi your house into a 5% rate even if you are underwater (125% LTV backed by Fannie and Freddie) and this is all before “Obama Stimulus #2 passes”. Plus if you work for any of the bankrupt companies or states (GM, AIG, California, any bank) you get your salary paid in bailout money. Its going to just keep expanding till the government pays everyone to exist. A few of the big buildings in my town have switched from private to public in the last year, pretty soon they will all be public.. (or Quasi-public like any bank, etc)
Well, all I’ll say is…Hold for the will.
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