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.