Cycle of Deflation

A little selection from Seeking Alpha regarding "competitve deflation" which seems the next stop on the cycle.

...In the early 1930s, countries around the world engaged in competitive devaluation. The idea is that by devaluing our currency, our exports become more competitive which reduces unemployment. The problem is that currencies are a zero sum game. Our devaluation is another country’s appreciation. This means we’re effectively just shipping our unemployment overseas. Other countries don’t like that, so they devalue their currency in turn. This leads to cycles of competitive devaluation. Competitive devaluation may lead to very severe inflation, or, if the economy is sufficiently weak, it may simply lead to extreme depreciation.

What would extreme depreciation without inflation look like? The prices of everything would go up, but wages would lag. Inflation is a cycle that is led by wage growth. If there is sufficient unemployment, labor has little negotiating power so they can’t get significant wage increases. So for example, prices might rise by 50% while wages only rise 15%. We are all effectively much poorer.

I believe that extreme depreciation (with or without inflation) is a near certainty. The tricky question is when. If we have another deflationary shock to the system, there would likely be another flight to the dollar and another wave of deleveraging which would actually cause prices to drop. In the absence of such a shock, I believe we would get significant depreciation (and price increases) within one year. My best guess is that we will see a shock and therefore the depreciation is a couple of years away, but I have no confidence in the timing.

It is very hard to profit from depreciation. Safe haven assets like gold tend to preserve wealth, but won’t necessarily increase it. Moreoever, if we have a deflationary shock first, gold and other hard assets could plummet like they did at the end of 2008.

I believe the best way to position ourselves is to gradually scale into a long position in hard assets, hedged with short equities. Today, owning some gold is smart diversification. If we get a deflationary shock that sends gold down 25%, hard assets like gold, commodities, and real estate, will be very attractive purchases. So, begin to very slowly scale into owning hard assets, but make sure to leave plenty of cash to buy more on a deflationary shock. To be perfectly clear, my best guess is that hard assets fall over the next year, but I expect them to be a good purchase over the next decade. Given my uncertainty on the timing, it is prudent to begin scaling into a long position very slowly over the next few months....

This was written last year.........  It is hard to guess what to do.  Gold and silver are now on a run, but to a large extent, they merely reflect the drop in the buying power of the dollars.  Metals may decline in a deflation, but that decline is not real because the dollars you would get for it will buy more. The standard of analyzing investment is not fixed. As the article mentions, keep some cash around in case things to crash so you can buy more for the buck.  The crappy dollar could once again have value once the toilet flushes. 

At the bottom of the curve is where you need a gun.

Numbers, deflation, inflation

Some recent numbers of interest from the WSJ:

• Gold SPDR ETFs in first six months of 2010:  up $7.4 billion
• Long Term Treasury Bonds 1/10 to 8/1/10:  + 15.5%
• S&P from his 1/07 to 8/6/10:  - 28.35
• Home price average from 2006 to today: - 29.1%
• 2010 Consumer Price Index:  +1.4%   (projected: +1.5 to 2%)

These numbers show the continuing disinflation and deflation as to prices. The FED is fearful of deflation as it will hurt the government coffers and Wall Street; further, it is immune to jerry-rigging, unlike inflation.

In a these times, it doesn't hurt the average person with gold or even cash sitting around at a modest return. Stocks are problematic as demand declines and companies continue to batten down the hatches. Still, a solid consumer-based stock, best with a  dividend, should survive well enough.  

As noted previously, one school of thought was to go all-in on government long term bonds, which you see above have done very well.

IMPORTANT:  TIPS can lose principal in deflation. They are great during inflation, however.  The WSJ says zero coupon bonds, aka strips, are better since return is locked in and the dividends are reinvested at that rate. Of course, then what do you do if inflation takes off?  It is not easy for real people to jump in and out of investments, most of us have jobs.

Hedging seems a good plan.  Perhaps, have some TIPS and some cash. If deflation appears, take a hit on the TIPS, but the cash will balance it. Then, when it looks like the high inflation is coming, buy TIPS.

If we slide into deflation, cash is king, the opposite of its status during inflation.  You can see the money changers who deal in credit do not want deflation.  Here, if you can find a pleasant return or good dividend, that may be the smartest thing.  In deflation, you will want to have your money in US cash, the opposite of the threat I have been harping about.  We are at the crossroads.

To paraphrase Hamlet, there is much provenance in the fall of a rate.  It is not be now, it be later. If it not be inflation, it will be deflation....   And so on.  One has to hedge one's property.  Prepare for both events, as both will come.  If not now, later.

If you speculate and guess right, you come out way ahead.

One of the early mega-wealthy Russian tycoons ordered thousands of Lada cars, with the help of a down payment garnered from friends, as he was certain the Rubble would crash, and I mean crash.  It did and he purchased the cars for pennies on the old Rubble as the contract price was in inflated currency. This would be akin to actually getting a fixed mortgage before an inflation.

So,  defense and offense is good.  Waiting in line for the shearing is not, as you can be whip-sawed in both directions.  

Musing about Deflation

As I noted recently, the people who need a full-time job and can't get one is about 24%, give or take an irrelevant percentage.

Our geniuses tell us all is going well. Here is the FED's official projection of inflation rates.  They act to control these rates and have an official policy to have no deflation and control inflation. Greg points out often that deflation is not a bad thing, just a part of the economic cycle, unless government makes it horrible by stalling it.

Keep in mind, nearly everyone uses deflation to mean prices going down. You may think, hey, what is wrong with that, I have a good savings account?" 

The answer is not much, really, only the big "Wall Street" hustlers and the government will be crippled by deflation.  Hence, the FED promises to stop it.

Also, note, from an investment house newsletter:

• Private construction spending — down 62% from the peak!
  
  
• ISM Manufacturing Index — close to stalling.
  
  
• New home sales — worst June on record.
  
  
• Factory orders have dropped twice in a row, down 1.2% June and 1.8% in May.
  
  
• Unemployment is stubbornly high, and claims are starting to increase — again!
  
  
• And California ... ay-yi-yi! The bad news is that bankrupt state may start issuing IOUs this month. The worse news is California may be the canary in the coal mine for the other states, and struggling municipalities.

Last week, we had another announcement of a six figure loss in jobs, but, not to worry, the unemployment rate remains the same, again! (It is now above nine percent for two years; the last time that happened was during the often invoked "Great Depression.") Perhaps, the whole country could go on welfare and unemployment and the rate will drop to zero%.  Now, that would be a recovery!

Oh, Apple announced it will be hiring some 200,000 people in China as soon as its new factory opens. Apple is a big supporter of Mr. Obama's American socialism. You sort this out.  Hint:  Ruling Class Pandering.

This is all rehashed to remind you things are not good, even in Saratoga Springs which is now catching up with the rest of the country.  They say trends move from CA east.  I think we are at the end of the pipeline.

I come to the point of this entry:  "A Lover of Treasurys Bets on Deflation" is an August 7, 2010 Wall Street Journal article. (I am not sure, but shouldn't "Treasurys" be a "sic.")

It seems the Holsington Investment Management company that handles some $5 billion in investments has been preparing for significant disinflation or deflation. The article notes this is contrary to common opinion and also notes the company outperforms everyone in its niche with a 9.3% return per year dealing only in Treasuries. That is better than the stock market return. 

These guys do not deal with clever investment tricks or have rapid-fire programs, they read economic data and shift assets to meet coming interest rate shifts.

The company thinks inflation will drop to near zero making Treasury bonds increase in value.  They think, in the end, the Treasury Bill rates will dip to 2%, which makes the price of the bill rise. The company will shift if it sees a change brewing, but right now they do not see inflation. 

Deflation is the giant monkey wrench if you are planning on inflation. The question is "what do you do." I ponder of the idea that you can't fool mother nature, just slow her down.  The FED and Treasury Department can try to alter the normal business cycle, but they can't hold the water back as they jerry-rig a dam. They are merely increasing the pressure.

Please add any input. 

To put things in perspective. If there is deflation, then those holding cash (or Treasury Bills) will be king.  If there is inflation, they will be pawns. This is a true dilemma - when considering what to do.

Here is a thought, let me know what you think:  borrow money.  If there is inflation, it will be paid back with cheaper dollars, you make a profit if you invest the money.  If there is deflation, you have many dollars, properly invested, that will be worth much more. (but you still have pay the loan in old dollars, so you can hedge that bet with an ETF).

This is makes sense, but first we should look at the best survival moves.

We do not have a Hobson's Choice, where there is only one option, we have a "Lady or the Tiger" choice. 

Tick, Tick, Tick: 130%

Greg sent in an article I won't recap, just tighten.  Basically, while we are all concerned that our Debt to GDP may reach the crisis mark of 90% in a year or two, it is actually 130% now.  Greece is only 124%. This is a brave new world for the U.S. and we are facing draconian events.  High inflation is certain; a deflation is becoming probable.  Either way, life as we deluded ourselves to accept as normal is coming to an end.

This is a tough scenario.  IF we are looking at high inflation, you want silver or Canadian dollars and be out of the USD.  If we are looking at deflation, you want cash in the freezer because prices will move quickly decrease.  I suppose we have to entertain both notions and monitor what is happening.  I suspect metals will go down some 20%, unless Israel bombs Iran, and then take off in the last quarter, as we approach January 1 of the new future.

I thought oil may work as an investment, but as Greg noted, if deflation hits, the demand and price of oil will also deteriorate.

Note:  stock companies will be forcing income into this year, rather than have it taxed at next year's rates.  In addition, older people, who are smart, are reducing their estate now as the estate tax rate next year will be very high.  Now, it is 0%.  (If this concerns you, start giving away your money to your heirs, now, or set up a trust.)  So, there will be news factoids about how we have turned the corner, don't believe it.  Pick up Art Laffer's new book.

The government doesn't want you to have a realistic anticipation, as that will blunt their games, and the media/broker community is filled with hacks.  There appears breathing room for the time being;  on the other hand, the shoe of crisis isn't dropped slowly - it explodes on your foot

Of course, food and ammunition are always a good buy.

Republicans Pushing To Count GSE Debt Toward Statutory Debt Limit May Be Surprised To Find Real Debt-To-GDP Ratio Is 130%, And That Greece Is Amateur Hour

Submitted by Tyler Durden on 02/22/2010 18:49 -0500

• Congressional Budget Office
 
• Debt Ceiling
 
• Department of the Treasury
 
• Fannie Mae
 
• Freddie Mac
 
• Great Depression
 
• Greece
• Gross Domestic Product
 
• Joseph Stiglitz
 
• Proposed Legislation
 
• Sovereign Debt
 
• Sovereign Default
 
• Stress Test
 

A new proposal by House Republicans, lead by Rep. Scott Garrett (R., N.J.), is seeking to address changes to Fannie and Freddie accounting, along the lines of what has been previously proposed by Zero Hedge, and to not only include the GSE's losses as part of the Federal budget, but to also count the debt from the two mortgage zombies toward the nation's total statutory debt limit. As we stated previously, it is only semantics at this point which distinguish the GSE obligations from other Treasury obligations. Yet it is not just us, but the administration's very own Peter Orzsag who was pushing for consolidated GSE accounting two years ago. Yet with GSE debt most recently at $6.3 trillion, or about half of the existing Treasury debt, this would mean total US debt would not only explode by 50% overnight, but the recently  increased debt ceiling would be immediately breached and America would find itself in technical default (where it really is right now for all technical purposes).

Dow Jones has more:

A memo written by Garrett's office, which was released Monday, states that "now that the federal government has explicitly backed the operations of the GSEs, there should no longer be a distinction between their debt ... and the debt issued by the Department of the Treasury."

The proposed legislation highlights the current uncertainty surrounding the two firms, which have been under government control since September 2008. Federal officials were expected to provide some guidance as to their future plans for Fannie Mae and Freddie Mac in the fiscal 2011 budget released earlier this month, but that information wasn't included.

The Office of Management and Budget, which compiles the White House's annual budget request, did acknowledge in the budget the different ways the government currently accounts for the two firms. The Congressional Budget Office accounts for the two firms "on budget," treating them like any other federal agency. OMB, meanwhile, treats them "off budget," considering them to be private companies.

As we observed some time ago, "It would seem a little presumptuous that an amount representing more than half of the total US sovereign debt is conveniently swept under the rug." Luckily, there are people like Garrett to remind Obama and his henchmen that not every person in America is a zombified purchasing cretin with 10 credit cards and a limitless Centurion in the mail, who couldn't care less about America's sovereign default until 3 days after the fact. ... 

Pop quiz: what is the full faith and credit of a bankrupt entity?

And just in case you were confused, and have yet to recognzie the idiocy of the OMB, and the ruling class in general, here is a paper written in 2002, in which authors Joseph Stiglitz (a Nobel winner no less), and Jonathan and Peter Orzsag, whose opinions rotate by 180 degrees more often than a magnetic needle above true north, claim the following OMB-referential piece of unparalleled garbage:

...This implies that if Fannie Mae and Freddie Mac hold sufficient capital to withstand the riskbased capital scenario, they would likely fare well under any conceivable economic environment.

Ah, the OMB, which less than 10 years ago said the probability of a GSE default was close to zero. With such lunatics in charge of making the decision of whether the GSEs should or should not be considered Treasury debt, can we please just fast forward 10 years to the post nuclear war holocaust already. The constant barrage of daily bullshit is really getting tiring.

Sunday: The deflationary argument

Inflated Thinking

I should have known better.

The last blog had an ending note about the "-1" inflation rate and I mused that this is bad sign as it signals deflation.

Greg called to point out that there can't be a true negative inflation rate as, by definition, the massive increase in money supply is "inflation." I fell into the sloppy-use trap and I should have known better.

Inflation is not the term for an increase in prices. Period.

Inflation will result in the appearance of an increase in prices because the money is worth less. So, over time, the term inflation has come to be used as "price increases," which is not correct. Thus, under this use, the -1% inflation means prices went down, which makes far more sense as people start saving.

For that matter, maybe it means there was a reduction of the inflation rate by 1%. So, in addition to being wrong-headed, it is not well defined. I took the numbers to mean something not intended.

This is definitional thing, not a political, so don't write to tell me otherwise. I will pay more attention to what effluvia I post. We must not permit the politicians, with the help of the ninny media, to twist reality to fit some private hope for reality.

We are routinely told, for example, that inflation caused gas to go up, say, 10%. If supply and demand did not change, then the dollar cost went up 10% because the dollar was accepted for 10% less by suppliers. There is no true value of the dollar, only what

Another Word to the Wise (you)

No pictures today. Today, I use words. Don't need any cute media image. I seriously recommend you actually read this and not skim it as more rambling in your inbox. As the title suggests, a word to the wise is worth something or other. What is that, a pound of cure? Saves nine? A bird in the hand?
-----

Two years ago, Glenn Beck pointed out the government stopped reporting how much money it prints. Yes, prints. That is how we keep going after idiocy like Fannie Mae, etc. (No, no analysis of a scandal 30 times bigger than Enron, here. Fait accompli, for sure. No more fixes.) At the time, we were told no one really needs to know the printing information. Not part of the matrix of data. No?

Beck suggested there was no reason for this other than they expect to print a great deal of money.

Today, on his radio show, he pointed out that he had his staff spend time (a week) to find out how much money was printed recently (undefined, unless I missed it). The answer was more than $3,000,000,000,000. To put this in perspective, divide by 300,000,000, the number of Americans in the country, and this is a new obligation of $30,000 on EVERY American. No, it won't help to get more illegal alients.

Considering there are roughly 150,000,000 tax payers, business and personal, that is a new $60,000 debt on each taxpayer. Somehow, people seem to think these obligations are remote to their lives - they are not. But wait, there is more.

Then he pointed out that today's T Bill auction was the largest in history at $20,000,000,000, which you are liable to pay back. The paper commented today that the Treasury "still" had its lustre - as though it was an interesting phenomenon. You know, it is.

Only, it is not world investors, who are smart, are being tricked into U.S. obligations as much as there is no where else to go. The best of the worst? Word to the wise.

Oil prices are collapsing, making us feel better, like things are getting better. I had been predicting a fall to a rational price, one that wasn't controlled by fear. However, the rapid collapse of the prices, currently, is NOT a good sign, except in the very short term and to those who see the freight train coming. Consider the prices are collapsing because the smart money sees a dramatic collapse of demand. A bigger fear has taken over. In the future, if you have cash, you will be able to buy gas at a low price - a word to the wise.

A few weeks ago, I watched a C Span coverage of a symposium about the financial situation. An undersecretary of the Treasury, without fanfare, mentioned the government is planning for a deflation next year. A rapid deflation is a depression. I never saw that elsewhere on TV or in the paper, as we were in the Obama support game, at the time. There was no discussion of substance, only that the game was McCain going to Washington and Obama presenting himself as a more reflective, distant deep thinker. (As he said, Tell me what to do, I will sell it....)

The deflation should hit hard, the under secretary thinks, and last for the rest of year, plus. We all know how good the government is at projecting impact. However, I have no reason to doubt his overall analysis as this is classic economics, not government whimsy. Also, you can think of the gas prices as deflation, rather than a boon to buyers, as it appear. Don't fall for the superficial and stick to the word to the wise.

These are enough dots for me to shift to a prevent defense.

For my part, I am not as exposed as most, having been leveled by illness. Things can't get worse for me. In fact, I can switch to foreclosure law and use the downfall. So, I pass this along to those who feel motivated to prepare. If I am wrong, not a big deal, you will have lessened liabilities, have a basement filled with canned goods, some cash under the mattress, and may have an apartment in your house.

If I am right, you could easily lose your job or a major portion of income. Those around you will not be able to pay you. Prices will collapse, along with income, of course, but not your mortgage payments and government taxes. Not, government salaries which are now, what, 50% of the economy. Real estate taxes will not come down for some time as the government will be needing your money as its waste blows up in their faces. Governments universally don't understand revenue goes down as tax burden goes up. Just another junkie standing in the loser line.

Cash will be king. Get cash. Getting cash can also mean get out of debt. Now. That's the magic bullet. Shift debt to a form you could deal with. If you are over 65, get a reverse mortgage today.

This unrequested advice is not a general idea from a former blogger, it is a religious dogma to put into effect today, if you sense trouble. Don't put aside this info as as part of the mass of data that flows through life. As Bacon said of books (or something like it), some are to be tasted, others are to be carefully eaten and considered.

I am not projecting some economic downturn that we can stumble through because of the kindness of others. We are possibly looking at a wipe out caused by the stupidity of others. Again, if I overstate this, there is no downside to paying off debt and saving money.

If things are terrible, having a lawn sale, so to speak, today will be very important.

I am not an economist, so I would not presume explain how to prepare fully for a deflation. We have not had one in our lifetimes, unless you are old and knew it was coming all along. Deflation will require study and, perhaps, this site could be a way to look into what to do. For example, it seems buying gold and silver is smart, after buying food and storing it away. (Is gold artificially being depressed? What happens when holders of futures decide they want delivery? Is this AIG in a vastly more massive scale, there being no inventory to meet the demand?)

I am, however, acting on common sense. The coming mess is something a private business would have dealt with and fixed or reorganized. The government just prints money. Now, it wants to bail out car companies, because the unions want it and don't want members hurt. That is a nice idea, but at some point mommy government does too many stupid fixes which can delay a collapse, but increase the severity, as they say about the FDR projects.

At some point, world investors, upon whom we are addicted, will say, "Enough...." This is already starting to be heard around the world. The U.S. dollar is losing its appeal, overnight. This means something to you - directly. It is not some abstruse concept passed along to those who watch financial networks.

We are used to the government gliding over its massive mistakes. Remember Enron and the massive media interest and convictions? Congressional outrage at those big bad business people? (That Bush put them in jail was not part of the propaganda.) That episode was what happens when there are those in charge who have no decency or care of the rules of the game. They screwed up and are in jail. People are hurt. We are told the government should control all this.

So, what happens when we put loose cannons in charge of Fannie May and Freddie Mac, who think other people's money is to be spread around to voters regardless of economics? The result is a financial fiasco for the history books of future generations, far overshadowing in size and all other disaster than an Enron episode. Everyone on the planet will be hurt.

We print $3,000,000,000,000, borrow $20,000,000,000, and McCain says, as president he may hire Cuomo, patient zero of financial collapse. Who are these dopes? Who? Why aren't people being arrested? Thrown from office? Who is responsible.

We are.

Indeed, Cuomo was voted into the insanity of NYS government, a perfect home. There really is no hope for NYS as long as NYC remains part of the country.

Anyway, just understand it is time to remove yourself from game. The game is not only on the cliff, it is sucking in more and more victims in an attempt to balance its position on the cliff. It is losing its stability, so is sucking in all of us. Sooner or later, down we go.

In the past, I told clients that "the bank is never your friend." Now, I will add, "The government is your enemy." Indeed, it is your pusher who needs more from you to protect itself. It has stopped being America's representatives and we went along with that. It is now Big Brother, the crazy one.

So, a word to the wise.

Ideas to consider, immediately, like now:

1. Reduce assets to protected cash, perhaps gold. (Stop spending)

2. Get out of debt asap. Even if all you can do is lower interest cost, do it. Shift things around.

3. Don't buy anything that requires borrowing money. Indeed, sell your house if you are near the mortgage amount, or prepare to pay the mortgage with much less income....see below.....

4. Do a budget that assumes your income is reduced, one day, by 50%. Consider a plan that includes bankruptcy. Put assets in the right places.

5. Watch for the credit status of the U.S. being lowered - that's the writing on the wall that all hell is coming. Foreign money will vanish at a geometric rate. Followed by the collapse of the dollar. Socialist will say they need control, you can't let citizens run their own country. Game over.

Have a nice day.

The Arabs have a saying, "Trust in Allah, but, first, tie up your camel."

Final word to the wise: take Vitamin C. Especially, if you get the flu, take, at least, 5 grams a day. Forget the delusional vaccine which is just another way to get money from the government by drug companies. Flu victims die of scurvy - the absence of Vitamin C. How simple (aka cheap).

Gene

Good luck.