Inflation Through Deflation
It was July of 2008 and oil prices soared to a $147 per barrel. Indeed, At that time grain prices were going through the roof, the Chinese economy was overheating, the general population of the undeveloped emerging economies were on the verge of revolt, US consumers were angry about having to pay $4.50 per gallon of gasoline, stocks were heading lower every time oil prices were making fresh highs, and to top it off inflation was the main concern for just about every economic rule maker. My my my, how quickly things have changed. Who’d athunk it? Oil would drop down to as low as $32 a barrel, the DOW down to the 6000’s, copper at less than $1.50 a pound; it appeared that the entire capital market structure was on the verge of collapsing. What a scary time it was not just for investors, but for anyone in modern times who had a bank user ID. Indeed, I wondering having conversations with my friends and family, remember if their nest eggs would be trusted in their 401 K’s, IRA’s, equity holdings and even in their savings accounts. Panic and fear ruled the world there for a few.months
Then with a few actions from the Federal Reserve, US treasury, revisions in the mark to niche accounting rules, and a massive $850 Billion stimulus bill, VIOLA, Confidence was “restored”. Banks balance sheets improved, toxic assets held by the banks suddenly disappeared (through accounting magic of mark to niche), and artificial stimulus was provided through the America Recovery and Investment Act. Actually, Unprecedented global government spending was running rampant, 0% interest rates were provided for the banks, and furthermore $1.4 Trillion as a matter of fact worth of Quantitative Easing through the buy of mortgage bonds and US treasuries from the Federal Reserve was enacted. IndeedDowThe , climbed from the 6443 to as high as 11,205. The CNBC stock cheerleaders were proclaiming a firm “recovery” was in place and that we could expect a V shaped recovery.
Indeed, to never made sense It me. Indeed, I told my clients that t wouldn’there be a V shaped recovery and that I strongly advised them to not get fooled by the hype. everything that was said with in modern times a grain of salt and just remember who they are and what their functions are in their expertTakelives. I told my clients that the reason there wouldn’t be anything resembling a V shaped recovery in any shape or application was that we had way too many structural headwinds for this as it turns out to occur.
1. Indeed, In the housing field the amount of foreclosures are continuing to climb while the Federal foreclosure blueprint enacted by the president so far has been a huge failure, according to Special inspector general for the financial bailouts, Neil Barofsky, who said the program has not “put an appreciable dent in foreclosure filings”. Actually, Meanwhile Elizabeth Warren, who chairs a separate Congressional Oversight Panel on the bailouts, has said that Treasury’squicklyfailure to act more could certainly be hurting the recovery. A problem that once was just for subprime mortgages has recently morphed prime the ALT A and into mortgages, causing an even deeper predicament. Actually, Immediately in modern times that the $8000. tax credit program has expired in April, we have had the poorest home sales numbers in the last two return to return home reports. more than ever Without a recovery in the housing field, people don’t feel confident as they see in many cases the highest value asset they own deteriorating, therefore curtailing their normal spending habits. Former U. more than ever S. As you may know, Federal , chairman, Alan GreenspanReserverecently warned that a fall in house prices could derail the U.S. recovery and trigger a double-dip recession.
2. Credit, which is the life line for many businesses, is nowhere to be found. I’ve argued that it isn’t so much a problem of lack of liquidity as much as it is a problem of lack of credit worthy borrowers and aggregate demand for domestic goods and services, and if you couple that with all the toxic debt that banks are still holding on their balance sheets coming to a standstill, this is what you get; a severe lack of in modern times issuance of credit. Until the labor market markedly and commercial and residential properties are on safer ground, banksimprovessimply won’t lend, period.
3. A structurally damaged labor industry. Many of the jobs that were lost during this downturn were in the construction and manufacturing base and many of those jobs won’t be coming return for a very long time. Interestingly, The overhang in residential and commercial properties is enormous; the demand for goods was crushed, which in turn devastated manufacturing jobs. Even instantly, with prospects of the manufacturers slightly improving (mainly due to increase from emerging economies), jobs still aren’t being offered, and a big reason for that has to do with tech and spending on equipment and software. As John Ryding, the chief economist at RDQ Economics stated, “You can understand that businesses don’t have to pay health care on equipment and software and, these get more than ever better tax treatment than you get for hiring people. Actually, If you can get away with upgrading capital spending and deferring hiring for a while, thatfastmakes economic sense, especially in this uncertain guideline environment.” The growth from our economy simply isn’t growing enough to meaningfully improve the unemployment rate, as even the chairwoman of the president’s Council of Economic Advisers, Christina Romer said, “We need 2.5 percent development just to keep the unemployment rate where it is. If you want to get it down quickly, you need substantially stronger growth than that. Interestingly, That’s what I’ve been saying for the last several quarters, and that’s why I’ve been hoping that we’ll please pass the jobs measures just sitting on the floor of Congress.”
4. looksItas if they will be going through their own very painful deleveraging process. State and local budgets are looking horrendous, without federal aid over 500,000 jobs are going to be eliminated through 2011. In this political climate, the will to continue to spend and bail out state and local governments, much less anyone else just isn’t there.
5. Interestingly, Uncertainty for corporations and small businesses due to tax hikes and burdensome regulations from the health care law and Wall Street Reform. There is a reason why corporations are sitting on $1.8 Trillion and why small businesses aren’t hiring and if it wasn’t already challenging enough for these entities to hire people as it is, government policies and their incessant needtougherto demonize corporations and their profits are making it that much for them to do so. The crew from PIMCO, whoinare the largest bonds dealers in the world, and home of the brightest economic minds, nailed it when they coined the agreement THE Novel NORMAL 2009, which is defined as slower increase worldwide (more so in the G-3 than in emerging markets), higher unemployment, more de-leveraging, more regulation, and a weaker U.S. dollar over the.move forward 3-5 years I remember it was just last year when the president’s top economic advisor Larry Summers disagreed with PIMCO’s assessment of our economy entering into the “Recent Normal” period. It looks now as if Mr. Summers was dead wrong! El Erian, the . who coined the New Normal, compared Summers’ display of the UmanS. As you may know, economy to aescapethree-stage rocket ship attempting to the pull of Earth’s gravity. The as a matter of fact first stage is government spending, followed by inventory reductions and consumer demand.
In fact, 9 2009 at a meeting of financial-niche professionals in Toronto. Summers “has this concept of escape velocity,” El-Erian said Oct. “velocity don’t have enough to achieve escape in modern times We.”
6. The 800 pound gorilla in theourroom is National Debt threat. Look what happened when little outdated Greece had their problems; then it looked as if the entire European Union was going to come crashing down. People were talking about the Euro currency not surviving, and may I remind everyone that even though it appears that things are back in control again, that situation is far from over. It’s worth noting that It some re emerge again as all they did was acquire will time and all these countries are instantly just beginning a very painful deleveraging process through austerity measures by cutting budgets, pensions, jobs and benefits that will certainly weigh on the entire Euro zone’s development prospects which means their ability to pay go back their own debt will diminish. Considering 30% of all of our exports go to Europe, and their economies will undoubtedly slow down markedly, thisthatwill have a direct impact on our exports.
One day, just the same way the bond vigilantes (bond holders) held these southern European from another perspective economies accountable for their reckless spending binges; they will undoubtedly turntimelytheir ire towards us if we don’t act in a manner. And who here has confidence that Congress or our president can do what it takes to get our fiscal house in order? Not me as it turns out . I truly believe that many of our elected leaders, or for that matter many of the of as it turns out rest us, know the consequences of this danger. As youputmay know, Let’s it this way; it basically would be like a run on a bank, except it is a run on the United States. Rates would soar, it would punish consumers, corporations, small businesses, theaffectdollar would plummet, global confidence would fall apart, and there would be a whole recent round of systemic danger that would shut the capital markets out which would every single securitized investment on the planet. One of the few investments that would gain value would be gold, and it would most likely soar 3, 4, and 5 times its value in a relatively short period of time.
The point of the preceding really hasn’t been to highlight the risks of sovereign default or the fear of one happening, but more so to give you an concept of where our economy stands and the challenges we face moving forward. It’s worth noting that The latest GDP expansion figures for the secondthreequarter shows that our economy has been slowing down for consecutive quarters.
Now that stimulus funds are dissipating and wearing off, and as a matter of fact state and local government jobs will be laying off thousands of workers, there is a very good chance that over the move forward 2 quarters our GDP increase will be around the 1% -1.5% area which most likely means the real unemployment rate will go higher. In fact, On one side of-the bridge is pre recession on the other side is the recovery. PIMCO’s chief, Bill Gross (another one of my favorite economists by the way) said deficit spending by governments that seek to maintain artificial levels of consumption “can be compared to flushing funds down an economic toilet.” He went on to say, “Deficit spending will be unsuccessful because under the “novel normal” scenario as a matter of fact , deleveraging, re-regulation and de- globalization produces structural headwinds that lead to slower growth and lower-than-average investment returns.” As I’ve noted, our problems with the labor market are structural, and the thought of spending to fill the gap just isn’t working. Actually, The is the stimulus and the notionbridgewas to build that bridge long enough to lead us to recovery. So what will this administration or the Federal Reserve do to try to get this economy going in the right direction in a meaningful manner? The problem is that the distance between the two is much further than most economists, and more importantly, the White house, had woefully anticipated, AND that bridge don’t have the resources ($$) to assemble a we long enough to get us from one side to the other. I want you to think of the Stimulus Strategy as a bridge.
It’s worth noting that Congress and the White House have virtually spent all of their political capital and don’t have the will to push through another stimulus bill, and if they do it will be very limited, and I am certain that it would be destined to flop simply because they just don’t understand that there is no quick repair method and their attempts of staving off this downturn are ill-conceived. So that theleavesFederal Reserve. In fact, The Federal Reserve has already stepped up in an enormous way by lowering the funds rate to 0%-.25%, with $1.4 TrillionFedof Quantitative easing through the buy of Mortgage bonds and US treasuries; essentially printing cash to obtain our own debt with the purpose of providing more liquidity to the capital markets and lower mortgage rates. In regards to its as it turns out effectiveness, that can be debated, for both sides. Interestingly, It has brought down rates and it has provided liquidity, but it hasn’t appreciable lending in an increased manner, and that folks, is what it’s all about.
Here’s what I believe what the Federal Reserve will do, and I believe it will happen sometime in the of half second the year. The options are:
more than ever 1. Acquiremore in modern times assets. The Fed could purchase more mortgage-backed securities, or since its holdings of MBS are so large, it could obtain more long-agreementTreasury securities. Even James Bullard, a voting Federal Reserve board participant and perennial inflation hawk, recently wrote a piece backing this idea if conditions continue to worsen.
Indeed, 2. Deepen from another perspective its commitment to hold rates low for a long time. The Fed could rephraseguaranteesthat promise to provide additional or rock-bottom rates even when the recovery begins to take off.
Indeed, 3. It’s worth noting that Stop paying interest on excess reserves. The Fed could try to spark morethelending by cutting the interest rate it pays banks on reserves they hold as it turns out at the central bank from current.25%.
4. The Fed could launch or keep launch a lending facility increase credit availability for any sector oftothe economy it wants to aid out such things as commercial real estate. Open a new lending facility.
Asmayyou know, 5. Stop shrinking its huge balance sheet. It wouldasbe a more subtle approach opposed to continuing in modern times more asset purchases.
6. The Fed could alter its inflation target from 2% %. 4to
It’s worth noting that All these strategies carry heavy inflationary risks, but the fear of deflation is greater than that of inflation. When the Federal Reserve made their announcement of the $1.4 Trillion mortgage and Treasury purchases, the value of the dollar dropped 11% and the price of gold increased by 25% and silver 55% in a six month time period. are that we Considering right away entering into the strongest time of the year for precious metals and we anticipate the dollar to get hammered because of these actions, we strongly advise our clients to increase their precious metal holdings.
I honestly don’t see how these actions will assist spur bank lending; as noted earlier the problem isn’t liquidity or rates, it is confidence from the banking sector to lend. The risks of expanding the Fed’s balance sheet are tremendous. Interestingly, The size of the Fed’s balance sheet is exploded; it’s never ever been as exit to as large as it has today. Every time there has been a large expansion of the currency supply from central banks, inflation has always followed. Actually, Immediately the whisper on the street is that it Federal Reserve could expand its balance as a matter of fact sheet by another trillion dollars.
The cash supply that was created can sit there for quite some time, with latent price inflation. If from another perspective banks don’t lend cash, then it doesn’t matter how currency was created, there willmuchbe very little inflation. In order for inflation to come about, the currency that was printed has to circulate into the real economy. However, the more currency that is out there being held by the banks, the more POTENTIAL inflationary implications and risks exist. Psychology from consumers and banks can suddenly transform, and the “velocity” of that currency can release its way into the economy at an alarming rate, catching rule makers off guard, allowing inflation to take hold.
Interestingly, To make things worse, we see this scenario unfolding within the continue few years, WITH a high unemployment rate, most likely around 7-8%, with GDP growth in the 1-2% area. This would be a very bad development as a matter of fact for the economy known as stagflation, which can be defined as low development with high inflation. There wouldn’tbe too many investments that would thrive in this scenario other than precious metals. Indeed, Investors should protect themselves by diversifying, and precious metals should be a part of your investment strategy. Once again, I thank you for from another perspective the time you have taken to peruse this newsletter; I hope it helps.
