Copper prices have now confirmed the market slowdown suggested by the inventory build. The spot price dropped through $3 /lb today. Stock markets also sagged, and are down substantially from mid-January highs.
This is increasingly looking like the dreaded "next leg down."
Tickers to keep an eye on: PSQ, DOG and the like, plus SMN and BOM.
At least, I've got my eye on them...
Thursday, February 4, 2010
Friday, January 29, 2010
A Wee Little Bit of Deflation
M1 has ticked downwards in recent weeks. In addition, the Adjusted Monetary Base (AMB) has also turned down, indicating that the monetary contraction is being engineered by the FED:
Yes, that's right, I said it -- deflation. The charts don't lie.
But note that this is a deliberate policy of the FED, not some spontaneous, out-of-control money-destroying spiral envisioned by the deflationists. It is also a small event, and might easily be reversed in coming weeks.
Note also that this does not negate the inflationist hypothesis. It is entirely consistent. The inflationary process inevitably creates inconvenient price distortions that must periodically be squelched by monetary tightening. I do not know what particular effect disturbs the FED at this time, but it appears to be taking action. If the trend continues, expect a major recessionary event, followed by a reinvigorated policy of monetary inflation.
But in the short run, bulls -- beware the matador's cape! Pay no attention to the FedFunds rate, for it only serves to conceal and distract attention from the deadly prick. It is meaningless. Bernanke is playing the same game he played in 2007. He claims to keep the rate "low" while refusing to add to the money supply. But the astute will know what this means -- Bernanke does not drive the rate lower. The market itself does. The FED is deflating, but Bernanke claims to keep the rate low and gets to play innocent bystander while the market crashes.
Or rather, to be somewhat more precise, the market distortions which have already occurred are finally revealed upon stabilization of the money supply.
The whole ruse works, of course, because the public believes in the interest rate narrative and the legitimacy of fiat currency regimes. I think even the FED believes it. It doesn't seem to occur to them that fraudulent accounting is just that -- fraudulent. It doesn't reflect reality. "Low" and "high" are relative terms. Relative to what? The Austrian school knows -- market rates!
It doesn't matter all that much whether interest rates are low or high, or rising or falling. What matters is whether money is being created or destroyed to influence the interest rate away from its market value. Right now, this very instant, the FED is destroying money while pretending to be "accomodating." Bernanke is behaving perfectly in character in doing this, as it is exactly what he has done in the past. He is being as tight as he can be, attempting to extricate himself from the FED's bloated balance sheet without visibly impacting markets. He won't be able to. The assets he bought cannot be sold in any meaningful volume without triggering a financial backlash and recession.
The money supply is falling very slightly, and the rate is what it is. The FED is not supporting financial markets. If it keeps to its present course, expect them to fall. When the free market assigns an interest rate of near zero, things are really, really bad.
So long as the public believes in this illegitimate system, it will never grasp the fact that virtually all financial calculations made under the monetary pretenses of a central bank are incorrect. Just a little bit of common sense should reveal this to even a mediocre intellect. Yet the delusion persists. Why does the public believe this charade? A few days ago, I would have called it a conspiracy. But it seems that is not the proper term.
Maybe I'll address the issue, at least to the best of my abilities, some other time.
Yes, that's right, I said it -- deflation. The charts don't lie.
But note that this is a deliberate policy of the FED, not some spontaneous, out-of-control money-destroying spiral envisioned by the deflationists. It is also a small event, and might easily be reversed in coming weeks.
Note also that this does not negate the inflationist hypothesis. It is entirely consistent. The inflationary process inevitably creates inconvenient price distortions that must periodically be squelched by monetary tightening. I do not know what particular effect disturbs the FED at this time, but it appears to be taking action. If the trend continues, expect a major recessionary event, followed by a reinvigorated policy of monetary inflation.
But in the short run, bulls -- beware the matador's cape! Pay no attention to the FedFunds rate, for it only serves to conceal and distract attention from the deadly prick. It is meaningless. Bernanke is playing the same game he played in 2007. He claims to keep the rate "low" while refusing to add to the money supply. But the astute will know what this means -- Bernanke does not drive the rate lower. The market itself does. The FED is deflating, but Bernanke claims to keep the rate low and gets to play innocent bystander while the market crashes.
Or rather, to be somewhat more precise, the market distortions which have already occurred are finally revealed upon stabilization of the money supply.
The whole ruse works, of course, because the public believes in the interest rate narrative and the legitimacy of fiat currency regimes. I think even the FED believes it. It doesn't seem to occur to them that fraudulent accounting is just that -- fraudulent. It doesn't reflect reality. "Low" and "high" are relative terms. Relative to what? The Austrian school knows -- market rates!
It doesn't matter all that much whether interest rates are low or high, or rising or falling. What matters is whether money is being created or destroyed to influence the interest rate away from its market value. Right now, this very instant, the FED is destroying money while pretending to be "accomodating." Bernanke is behaving perfectly in character in doing this, as it is exactly what he has done in the past. He is being as tight as he can be, attempting to extricate himself from the FED's bloated balance sheet without visibly impacting markets. He won't be able to. The assets he bought cannot be sold in any meaningful volume without triggering a financial backlash and recession.
The money supply is falling very slightly, and the rate is what it is. The FED is not supporting financial markets. If it keeps to its present course, expect them to fall. When the free market assigns an interest rate of near zero, things are really, really bad.
So long as the public believes in this illegitimate system, it will never grasp the fact that virtually all financial calculations made under the monetary pretenses of a central bank are incorrect. Just a little bit of common sense should reveal this to even a mediocre intellect. Yet the delusion persists. Why does the public believe this charade? A few days ago, I would have called it a conspiracy. But it seems that is not the proper term.
Maybe I'll address the issue, at least to the best of my abilities, some other time.
Sunday, January 17, 2010
Market Update
Many apologies for my prolonged absence. Life seems to have hit a rough patch. Maybe someday the lesson will sink in that life is the rough patch, and that the successful learn to take it in stride. But for now, I'm going to mope about it and let it interfere with my bloggerly duties.
At any rate, here is a quick rundown of moderately significant recent market happenings that you, intrepid reader, should know about.
The FED
Bernanke once again denied that the FED had any responsibility for inflating the housing bubble and causing the financial crisis. It wasn't the torrent of money that caused prices to rise to the moon and instigated a financial feeding frenzy. No:
We will achieve Utopia here, and you will do what you're told! AND SMILE DAMMIT!
Note to idiot bureaucrats and politicians out there: it is difficult to defend yourself from charges of incompetence when the very thing for which you are responsible goes to the dogs on your watch. When you are running the show and things go wrong, it is, in fact, your fault. You will never, ever, be able to control it all. So, if you don't want to be blamed for every disaster that crops up, stop seeking to control every aspect of our lives!
If the FED weren't in charge of running the economy, it wouldn't be blamed when the economy went into meltdown. Case closed.
China
Jim Chanos, short-seller extraordinaire, has chimed in that he thinks China is headed for a crash:
By the way, how is it that Thomas Friedman actually manages to sustain a career writing financial columns?
The fact that China's central bank is "edging up interest rates and raising the proportion of deposits that banks must set aside as reserves" is exactly why asset prices will fall at some point and Chanos will indeed make a lot of money if he has shorted them. It doesn't matter that a stable money supply is the correct policy and the PBoC is right to move in this direction, when you inflate prices with a credit binge and then throw on the monetary brakes, prices fall. It's not rocket science. Thomas Friedman couldn't possibly make a better case for shorting the Chinese market.
Banking and the Housing Market
If we are to believe certain government pronouncements, always risky thing to do, several big changes appear in the pipeline that are extremely bearish for the financial and housing markets.
The FED has pledged to stop buying mortgage securities at the end of March. The housing tax credit is scheduled to expire this year as well. So far, our keepers in Washington have been holding the line on this declaration, unlike previous pledges to end the stimulus at various dates through 2009 which were all broken as it became apparent that this would put markets right back into contraction.
The Austrian theory of the business cycles states that once capital prices become inflated due to an increase in the money supply, propping them up will only be possible with further increases to the money supply, so that continual increases are necessary to sustain a market boom. This is why stimulus doesn't work: the stimulus must remain permanent to have the desired effect. Keynesian's don't believe this; they think that a liberal fiscal policy can tide the market over until it finds sustainable footing. IF the FED honors its pledge, an admittedly big IF, I guess we'll get to find out who is right. I'm not holding my breath, though.
Yesterday, Dear Leader Obama announced that the banking system should face restrictions on bank size and activities which sent the DOW skidding 200+ points. Today, it repeated the feat.
What a joke. Virtually every financial policy of government of the past century has been to favor consolidation of banks into ever larger and fewer entities and encourage ever riskier behavior. In fact, the FDIC depends on this consolidation to curtail claims against its assets, as do other "bank rescue activities" associated with the FED. They couldn't function without it.
The whole point of consolidation from an accounting perspective (which is the one that matters when you're talking about bankruptcy) is to merge healthy balance sheets with the garbage accumulated by croaking institutions to produce a mediocre, bloated, but non-bankrupt super-bank. (OK, yes ALL banks are technically bankrupt. Just so the Feds don't have to seize them. That's the point.)
I don't think anything needs to be said of the effects of persistent monetary expansion and easy credit, "moral hazard," and "too big to fail" policies. Suffice it to say that gigantic banks have been explicit government policy for generations. This is central to the entire regime that governs modern finance.
Don't expect anything to change.
As for restrictions on trading activities MAYBE THE GOVERNMENT SHOULD CONSIDER NOT ACTING AS AN INSURER FOR STUPID BEHAVIOR AND ALLOWING THE FED TO PRINT GOBS AND GOBS OF MONEY WITH WHICH TO GAMBLE.
Nah. Too easy.
Bottom Line
Two things are working against economic recovery. First, government efforts to "stabilize" markets are preventing prices from reaching market clearing levels. The result is a general seize-up, unemployment of capital and labor, and stagnation.
Second, in an effort to keep the transactions flowing and prevent a breakdown of the banking system, the FED is expanding the money supply to provide cheap, subsidized credit and the government is running fiscal deficits to "spur aggregate demand," in Keynesian parlance. This means that transactions are taking place under deceptive conditions that do not reflect true market forces. They therefore are not generating wealth in an efficient manner and are a waste of resources.
But room for monetary expansion is running out. Wages fell last last year while consumer price inflation was up around 3 percent. If you ask a Keynesian, that is not supposed to happen. If you ask an Austrian, prices should only rise when bidders, consumers in this case, have more money in their pockets with which to bid. So, where's the money coming from if wages are down? Hint -- one word, two syllables, starts with a W. Government spending is also an acceptable answer (oops! gave it away.)
There's your stimulus for you -- higher prices, stagnant employment, government fostered dependency. The time is close at hand that the FED will likely curtail its expansion in response to pricing pressures. It may already be upon us.
My expectation is another round of tightening, with consequent falling capital goods and commodity prices (houses, stocks, gold, etc.) and another round of layoffs. Private debt will contract as borrowers go into default. Government debt will expand as tax revenues fall and more stimulus and bailouts demand heavy borrowing.
After the round of tightening and consequent recession, the FED will expand the money supply again, and we'll likely start another round of phony recovery at an even higher price than the last one. A greater fraction of the price increases due to monetary inflation will be seen in consumer prices rather than capital goods, e.g. housing and the stock market. The net result of these activities will be to slowly put ever more of the population on the dole, frustrate private wealth creation, increase the government's footprint, and erode savings, the standard of living, and the value of the dollar.
When will the final inflation come? I don't really know. Maybe the next round is it. But one thing is certain -- the present is unsustainable and the government will not be able to pay its bills. Something will have to give, and every indication is that it will be the dollar.
...and, on the bright side, eventually the government.
At any rate, here is a quick rundown of moderately significant recent market happenings that you, intrepid reader, should know about.
The FED
Bernanke once again denied that the FED had any responsibility for inflating the housing bubble and causing the financial crisis. It wasn't the torrent of money that caused prices to rise to the moon and instigated a financial feeding frenzy. No:
“Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates,”he says. It was entirely the fault of that cursed free market, you see. You can't just let people do what they please and expect the world to keep spinning on its axis, at least if your going to run a proper utopian scheme. You can't have a free market and a central bank. Raising interest rates and stabilizing the money supply just wouldn't have done the job. It would have had consequences, namely, that the country would have had to face economic reality. What you need is tighter regulations, more oversight, to make the central planner's dream work.
We will achieve Utopia here, and you will do what you're told! AND SMILE DAMMIT!
Note to idiot bureaucrats and politicians out there: it is difficult to defend yourself from charges of incompetence when the very thing for which you are responsible goes to the dogs on your watch. When you are running the show and things go wrong, it is, in fact, your fault. You will never, ever, be able to control it all. So, if you don't want to be blamed for every disaster that crops up, stop seeking to control every aspect of our lives!
If the FED weren't in charge of running the economy, it wouldn't be blamed when the economy went into meltdown. Case closed.
China
Jim Chanos, short-seller extraordinaire, has chimed in that he thinks China is headed for a crash:
As most of the world bets on China to help lift the global economy out of recession, Mr. Chanos is warning that China’s hyperstimulated economy is headed for a crash, rather than the sustained boom that most economists predict. Its surging real estate sector, buoyed by a flood of speculative capital, looks like “Dubai times 1,000 — or worse,” he frets. He even suspects that Beijing is cooking its books, faking, among other things, its eye-popping growth rates of more than 8 percent.You have seen my reasons for believing China is likely headed for disaster in the short term and long term stagnation. I dealt with decidedly broader issues, but even focusing on the financial side of things as Chanos appears to be doing, things don't look good either. One simply doesn't inflate at 28%, have the government write stimulus checks equivalent to 18% of GDP, then suddenly tighten monetary policy and not get a nasty market hangover. You'd think that more folks would be in the China bear camp, but all the same, it is nice to be in the company of at least one actual investing genius.
By the way, how is it that Thomas Friedman actually manages to sustain a career writing financial columns?
[I]t is easy to look at China today and see its enormous problems and things that it is not getting right. For instance, low interest rates, easy credit, an undervalued currency and hot money flowing in from abroad have led to what the Chinese government Sunday called “excessively rising house prices” in major cities, or what some might call a speculative bubble ripe for the shorting. In the last few days, though, China’s central bank has started edging up interest rates and raising the proportion of deposits that banks must set aside as reserves — precisely to head off inflation and take some air out of any asset bubbles.So, ummm..., China has a super easy money policy, and, then ... it ... ah, it goes and tightens said policy, but ...er, umm..., well Chanos just somehow isn't going to make any money shorting the market because he's just wrong. Go China!
And that’s the point. I am reluctant to sell China short, not because I think it has no problems or corruption or bubbles, but because I think it has all those problems in spades — and some will blow up along the way (the most dangerous being pollution). But it also has a political class focused on addressing its real problems, as well as a mountain of savings with which to do so (unlike us).
The fact that China's central bank is "edging up interest rates and raising the proportion of deposits that banks must set aside as reserves" is exactly why asset prices will fall at some point and Chanos will indeed make a lot of money if he has shorted them. It doesn't matter that a stable money supply is the correct policy and the PBoC is right to move in this direction, when you inflate prices with a credit binge and then throw on the monetary brakes, prices fall. It's not rocket science. Thomas Friedman couldn't possibly make a better case for shorting the Chinese market.
Banking and the Housing Market
If we are to believe certain government pronouncements, always risky thing to do, several big changes appear in the pipeline that are extremely bearish for the financial and housing markets.
The FED has pledged to stop buying mortgage securities at the end of March. The housing tax credit is scheduled to expire this year as well. So far, our keepers in Washington have been holding the line on this declaration, unlike previous pledges to end the stimulus at various dates through 2009 which were all broken as it became apparent that this would put markets right back into contraction.
The Austrian theory of the business cycles states that once capital prices become inflated due to an increase in the money supply, propping them up will only be possible with further increases to the money supply, so that continual increases are necessary to sustain a market boom. This is why stimulus doesn't work: the stimulus must remain permanent to have the desired effect. Keynesian's don't believe this; they think that a liberal fiscal policy can tide the market over until it finds sustainable footing. IF the FED honors its pledge, an admittedly big IF, I guess we'll get to find out who is right. I'm not holding my breath, though.
Yesterday, Dear Leader Obama announced that the banking system should face restrictions on bank size and activities which sent the DOW skidding 200+ points. Today, it repeated the feat.
What a joke. Virtually every financial policy of government of the past century has been to favor consolidation of banks into ever larger and fewer entities and encourage ever riskier behavior. In fact, the FDIC depends on this consolidation to curtail claims against its assets, as do other "bank rescue activities" associated with the FED. They couldn't function without it.
The whole point of consolidation from an accounting perspective (which is the one that matters when you're talking about bankruptcy) is to merge healthy balance sheets with the garbage accumulated by croaking institutions to produce a mediocre, bloated, but non-bankrupt super-bank. (OK, yes ALL banks are technically bankrupt. Just so the Feds don't have to seize them. That's the point.)
I don't think anything needs to be said of the effects of persistent monetary expansion and easy credit, "moral hazard," and "too big to fail" policies. Suffice it to say that gigantic banks have been explicit government policy for generations. This is central to the entire regime that governs modern finance.
Don't expect anything to change.
As for restrictions on trading activities MAYBE THE GOVERNMENT SHOULD CONSIDER NOT ACTING AS AN INSURER FOR STUPID BEHAVIOR AND ALLOWING THE FED TO PRINT GOBS AND GOBS OF MONEY WITH WHICH TO GAMBLE.
Nah. Too easy.
Bottom Line
Two things are working against economic recovery. First, government efforts to "stabilize" markets are preventing prices from reaching market clearing levels. The result is a general seize-up, unemployment of capital and labor, and stagnation.
Second, in an effort to keep the transactions flowing and prevent a breakdown of the banking system, the FED is expanding the money supply to provide cheap, subsidized credit and the government is running fiscal deficits to "spur aggregate demand," in Keynesian parlance. This means that transactions are taking place under deceptive conditions that do not reflect true market forces. They therefore are not generating wealth in an efficient manner and are a waste of resources.
But room for monetary expansion is running out. Wages fell last last year while consumer price inflation was up around 3 percent. If you ask a Keynesian, that is not supposed to happen. If you ask an Austrian, prices should only rise when bidders, consumers in this case, have more money in their pockets with which to bid. So, where's the money coming from if wages are down? Hint -- one word, two syllables, starts with a W. Government spending is also an acceptable answer (oops! gave it away.)
There's your stimulus for you -- higher prices, stagnant employment, government fostered dependency. The time is close at hand that the FED will likely curtail its expansion in response to pricing pressures. It may already be upon us.
My expectation is another round of tightening, with consequent falling capital goods and commodity prices (houses, stocks, gold, etc.) and another round of layoffs. Private debt will contract as borrowers go into default. Government debt will expand as tax revenues fall and more stimulus and bailouts demand heavy borrowing.
After the round of tightening and consequent recession, the FED will expand the money supply again, and we'll likely start another round of phony recovery at an even higher price than the last one. A greater fraction of the price increases due to monetary inflation will be seen in consumer prices rather than capital goods, e.g. housing and the stock market. The net result of these activities will be to slowly put ever more of the population on the dole, frustrate private wealth creation, increase the government's footprint, and erode savings, the standard of living, and the value of the dollar.
When will the final inflation come? I don't really know. Maybe the next round is it. But one thing is certain -- the present is unsustainable and the government will not be able to pay its bills. Something will have to give, and every indication is that it will be the dollar.
...and, on the bright side, eventually the government.
Friday, January 1, 2010
The Next Round?
It appears that Aaron may well have been spot on in his fine post concerning predictions for 2010. I have been bearish for a number of years, but I have a very hard time spotting exactly when the corners will be turned. The stock market rally that began in March was to be expected, but its timing, magnitude, and duration caught me completely by surprise. I have learned my lesson and try to keep my predictions relatively broad. But a fair number of indicators appear to be pointing to mid-2010 as a very trying time for the economy, more akin to 2008 than 2009.
Some of these indicators I mentioned last time. The accumulation of copper inventories puts the lie to positive manufacturing data, but a substantial fall in prices will be needed to confirm this suspicion. Prices continue to rise in the face of building inventories, a strange phenomenon that should heap doubt on the nonsense about recovery and more than hint at the real source of what we see.
But possibly the biggest threat is to the financial sector, and, once again, the mortgage market. In case you haven’t yet encountered it, here is one of those semi-famous graphs that has the finance commentariat in a tizzy:
(click to enlarge)
Notice the lull in mortgage resets through 2009. A “mortgage reset” is a contractually specified time point at which the up-front “teaser rates” for an adjustable rate mortgage expire and higher rates set in, rendering payments higher. For whatever reason, fewer resets for 2009 were written into contracts, so there has been a reprieve in foreclosure activity for about a year. But we sit on the very cusp of a return to 2008-level conditions. Expect foreclosure activity to pick up again in 2010, with consequent strain on the financial system.
This time around, though, we’ll already have 10+% unemployment, Washington will have much lower tax revenues to work with, housing prices will already have taken a hit, and our financial system will already be against the ropes.
It appears that Barney Frank and the rest of our keepers on Capitol Hill are prepared. They have authorized up to $4 trillion in additional bailouts (ht. Vox Day) from the FED “just in case” there is another incident as we experienced in 2008, which tells me they fully expect another financial emergency and don’t want to be caught with their pants down this time. I guess they’d rather it was our pants.
What will be the outcome of all of this? I’m leery about predicting too much, because so much is simply arbitrary, being as it is in the hands of our democratically elected overlords to determine. I suspect we will see another round of dollar strength, as, once again, people can’t pay their bills and cash becomes king. I repeat: that is a very different proposition from actual deflation, as I have no doubt that the FED will have the money spigots wide open. But we’re talking supply and demand here, and when everyone is desperately selling off their assets to acquire the cash to pay bills, cash is what’s in demand. Which is one of the reasons politicians want to print it in the first place. I expect that this will be the case until debt levels are substantially reduced, a state which I expect will largely be achieved almost exclusively through default, both outright and through money counterfeiting, not legitimate savings and paydown of debt.
One needs cash to pay bills, but one needs property to escape inflation. Safe, secure property, not paper. As long as present money printing is marginally less than present demand for paying bills, the CPI will be relatively tame. But once we get to the stage that the primacy of security against the bill collector has yielded to security against Bernanke’s printing press, the inflation will finally be revealed to all and sundry. Only some of us will have known the real causes and that the die was cast far sooner.
But I don’t expect we’ll get there in 2010. I certainly hope we don’t. However, I could easily be wrong. I’m only an amateur.
So, my prediction: going forward, deficits will not fall as predicted. They will climb. I think Aaron's guidance for 2010 is pretty good. I'm going with a round $2+ trillion.
Some of these indicators I mentioned last time. The accumulation of copper inventories puts the lie to positive manufacturing data, but a substantial fall in prices will be needed to confirm this suspicion. Prices continue to rise in the face of building inventories, a strange phenomenon that should heap doubt on the nonsense about recovery and more than hint at the real source of what we see.
But possibly the biggest threat is to the financial sector, and, once again, the mortgage market. In case you haven’t yet encountered it, here is one of those semi-famous graphs that has the finance commentariat in a tizzy:
(click to enlarge)
This time around, though, we’ll already have 10+% unemployment, Washington will have much lower tax revenues to work with, housing prices will already have taken a hit, and our financial system will already be against the ropes.
It appears that Barney Frank and the rest of our keepers on Capitol Hill are prepared. They have authorized up to $4 trillion in additional bailouts (ht. Vox Day) from the FED “just in case” there is another incident as we experienced in 2008, which tells me they fully expect another financial emergency and don’t want to be caught with their pants down this time. I guess they’d rather it was our pants.
What will be the outcome of all of this? I’m leery about predicting too much, because so much is simply arbitrary, being as it is in the hands of our democratically elected overlords to determine. I suspect we will see another round of dollar strength, as, once again, people can’t pay their bills and cash becomes king. I repeat: that is a very different proposition from actual deflation, as I have no doubt that the FED will have the money spigots wide open. But we’re talking supply and demand here, and when everyone is desperately selling off their assets to acquire the cash to pay bills, cash is what’s in demand. Which is one of the reasons politicians want to print it in the first place. I expect that this will be the case until debt levels are substantially reduced, a state which I expect will largely be achieved almost exclusively through default, both outright and through money counterfeiting, not legitimate savings and paydown of debt.
One needs cash to pay bills, but one needs property to escape inflation. Safe, secure property, not paper. As long as present money printing is marginally less than present demand for paying bills, the CPI will be relatively tame. But once we get to the stage that the primacy of security against the bill collector has yielded to security against Bernanke’s printing press, the inflation will finally be revealed to all and sundry. Only some of us will have known the real causes and that the die was cast far sooner.
But I don’t expect we’ll get there in 2010. I certainly hope we don’t. However, I could easily be wrong. I’m only an amateur.
So, my prediction: going forward, deficits will not fall as predicted. They will climb. I think Aaron's guidance for 2010 is pretty good. I'm going with a round $2+ trillion.
Sunday, December 20, 2009
The State of the Economy and Some Physical Economics
The Reserve Bank of India (RBI) appears ready to raise interest rates thanks to the predictable price inflation that has resulted from their stimulus efforts. On the margin, this is bullish for gold as it should cause a rise in the rupee against the dollar, and India is the largest market for gold in the world. The FED appears content to continue to ignore any consideration of exchange rate and continue its suicidally loose monetary policy, allowing the dollar to become toilet paper. The monetary base continues to rocket skyward:
In the wake of the collapse of Fannie Mae and Freddie Mac, the FED appears to have decided to single-handedly take over the responsibility of financing the nation's mortgage markets. Its balance sheet now consists of almost half mortgage-backed securities, with this asset class rising the fastest. I guess the FED has decided that openly flooding the housing market with money is better policy than all that beating around the bush. If it ever stops, look out below.
So, all around it looks like we are in for an inflationary future. However, on the other hand...
Beware the commodities markets!
Oil inventories are up. Copper inventories are up as well.
Gold and silver, being among other things commodities, may be facing a serious correction in the coming weeks or months as well. So, even though I'm bullish on gold long term, if present conditions continue over the short term, we could be looking at yet another broad asset price correction like we saw in late 2008. In a really screwed up way, this actually makes sense, because monetary policy of the first eight months of 2009 was "tight" in comparison with the last half of 2008. So, we should expect a correction now that we live in a bizarro world where a ~17% increases in the monetary base is actually small in comparison to the previous year. This will be a good buying opportunity, supposing of course that it happens, for those with the stomach for it. If you don't have any gold yet, this may be your last chance to get it under $1000 an ounce. But again, remember that nothing is a sure bet, especially in the short term. Unfortunately, I would expect extreme volatility in the markets for a long while to come as government attempts to prop up markets mask the underlying catastrophe and markets repeatedly correct downward. It's all going to be very confusing.
The FED and Congress cannot continue this game forever. Watch for attempts to "withdraw the stimulus." Any attempt to stem the flood of government money will almost certainly meet with recessionary consequences. The whole "priming the pump" analogy is completely false. The present pricing regimen is dependent on an expanding money supply. When it dries up, price correction and recession sets in. If it does not dry up, expect a nasty case of price inflation to begin to take hold. For the market to "stay good" the stimulus must be permanent.
Just for fun, I'm going to go out on a limb here and invent a new branch of economics to try to explain what I think is going on. I'm going to call it "Physical Economics." Don't take any of it too seriously, as I'm making it all up as I go along.
(Actually, that's probably a good rule of thumb, as it can't be healthy to read anything I write, much less actually think about it.)
Anyway, FEDsters like to use a "tightrope" analogy is often used to describe FED policy. According to the analogy, if monetary policy is too lose, inflation sets in. If it is too tight, recession takes hold. Borrowing a tool from the physical sciences, the phase diagram, we could depict the FEDster's philosophy something like the following:
FEDsters imagine themselves scrambling around trying to keep the interest rate "just right," using their monetary voodoo to fight that terrible, most destructive force of capitalism, the evil business cycle. In this phase diagram representing the imaginary physics of FEDworld, the interest rate increases along the vertical axis and the business cycle advances along the horizontal. By plunking one's finger down at the point that describes some hypothetical condition, one can determine the corresponding "state" of the economy -- recessionary, inflationary, or "just right" non-inflationary growth. The solid lines represent phase transitions, so that if the FED decides, for example, to dial down the interest rate from point A, the economy will undergo successive transitions from recession, to non-inflationary growth, to inflation. Assuming, of course that we could hold time/the business cycle still. Likewise, if we are at point B and the FED simply allows time to pass without adjusting interest rates, marching along to the right one finds that the economy will slip into recession as the business cycle undulates past and a point of the cycle is reached that requires interest rates to be lowered. I have also included a dashed line representing the free-market rate of interest -- the theoretical rate of interest that would naturally prevail under a regime of a fixed money supply.
The FEDsters seem to take this model for granted. It doesn't seem to occur to them that, first of all, the business cycle is not a natural phenomenon of capitalist economies but is actually caused by their own activities and the activities of their crooked cronies the banksters, and second that the upper and lower bounds that constitute their "tightrope" might not actually run parallel at all, but wind up crossing one another as the insidious effects of interest rate manipulation distort the economy. Their supposed "just right" zone is a figment of their deluded imaginations.
Because the business cycle itself is dependent on how interest rates are manipulated and the money supply tampering implied by these manipulations, a more accurate phase diagram would have to run in multiple dimensions as unique business cycles sprouted perpendicular to each unique point of any particular phase diagram. I don't want to try to do this because my head would probably explode, and I don't think it's worth it for a blog post. But allowing ourselves the approximation of a fixed business cycle, I think the phase diagram should look more like this:
The "just right" zone is merely an illusion. Just right is the market interest rate with a fixed money supply, which results in no inflation and no business cycle. Keeping the interest rate below the market rate, which is where the perpetually inflating FED keeps things, can have several different effects depending on just exactly where one is in the business cycle. Early on, it results in a market boom as capital asset prices surge ahead of consumer prices, which the FED and the general public confuse for "just right." Later on it results in outright price inflation, either as recessionary inflation (stagflation) or a more serious case of inflationary expansion, depending on how far the rate is suppressed and how badly the economy was distorted in the boom phase. Only if the economy goes through a period of recession will it recover. There must be a period of time for prices to re-equilibrate so that rational economic calculation can take place again. Either capital goods prices must be allowed to fall, or consumer prices must catch up to the inflated capital goods prices caused by the artificial boom to bring things back into line.
So, contrary to the FEDster's line of reasoning, by manipulating interest rates and the money supply, the FED isn't so much walking the tightrope as walking the plank of the artificial boom. Eventually it runs out of plank and must decide which school of sharks it would rather hazard to dive into.
So far, Bernanke appears to have put us into the stagflationary phase. He has opted for near zero interest rates. He could put us into the expansionary inflation phase by effectively dropping them past zero and charging banks interest for not lending out their reserves, or he could put us into non-inflationary recession by raising them. But a true recession would be a political disaster, and he seems to be unwilling to cross the zero-interest threshold. Likely we'll just sit here for awhile until the truth sinks in -- we won't be able to get growth without inflation. Meanwhile, unemployment and the deficit will climb and the standard of living decline. The inflationary expansion transition line will eventually undulate back up and the non-inflationary recession transition line back down, but there may be some powerful political pressures to "do something" in the meantime. OK, OK, so there already has been. There will also be the unfolding of national default to answer for.
Who knows where all this ends? Maybe the FEDsters will come to their senses and stop inflating. Then we can get back to meaningful economic transactions that build wealth instead of government enforced economic behavior that destroys it. Doubtful, but it might conceivably happen. Otherwise, we are doomed to a prolonged, steady economic erosion as economic reality takes its toll on the fantasies of the FEDsters.
At least, those are my best guesses, which probably aren't as good as any despite the assurance of the cliche to the contrary.
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