Wednesday, September 16, 2009

A Funny Thing Happened on the way to the end of the World

Dear Deflationists:

(In case you didn't notice...) Your head is rolling down the street, leaving a bloody trail all the way up to the bloody sword still in the hand of the various Central Banks. You had your day in the sun, but you're done. Toast. Kaput.

Remember, it was you guys that said that the Fed, the ECB, the Bank of Japan, etc... would not be able to reinflate, that they were pushing on a string - you had me going, too. I would make some money, take my profits and leverage a short trade, cover, lose money... rinse and repeat. I have heard the arguement for a double dip - and I even buy it - but that has not done me any favors.

Turns out, the Central Banks still have some mojo left.

I get very little satisfaction out of missing the funeral and then get lost trying to get to the wedding. It is supposded to be the other way around - "if you don't get an invite to the wedding, don't go to the funeral".

Oh, and the US$? You know, the currency that was supposed to sparkle in a deflationary environement? The US$ ain't twinkling folks, it tinkeling - all over itself. So, although the Central Banks still have "the power", said power does not seem to extend to currency valualtion.


Well, I did not think thet could do it this quickly. The Central Banks have pulled off a marvelous success in their effort to reinflate.

Here's the rub:

Oil is over $72 while the world's largest consumer of Oil is at the tail end of a miserable recession. What will the price of oil be if the Reinflation effort continues to work? $100? $150? $200?

This is the Conundrum. The American Consumer's ability to pay their TAXES, let alone necessities, goes out the window with gasoline at $4.00 per gallon, and at $5.00 they are flat on their backs. Any recovery at all - ANYTHING - and Oil is back over $100 per barell. Then... POOF!! That's the end of the recovery, with its concomitant decline in tax revenues (collections) yielding ever increasing budget deficits, which puts more pressure on the US$, which causes Oil prices to rise in US$ terms, repeating, ad infinitum. After all, the Central Banks CAN inflate asset prices, but employment is a very different animal. Asset prices are abstract, employment is real.

This process has begun, and each successive cylce will jerk us around like a puppy on the end of a leash held by Michael Vick's Dark Side.

Here is a link to the U.S. Department of Energy's weekly petroleum status report. Please note that the US has been drawing down its inventory in recent weeks as imports continue to decline and while it appears that we CAN reinflate, it seems it will be so at the expense of destroying the US$. This will no doubt make many American debtor's happy in the short term, but it will certainly accelerate the decline in Oil imports into the U.S.

And we all know what that means.

So, here we are again. The housing/financial issue put the energy energy issue on the back burner for perhaps 15 months.

"They're baaaaaaack!"



Anonymous said...

I was expecting another dip in oil prices. Not seeing it. But oil seems to be decoupling from gold. It hangs in there at about $70 while gold is creeping up and the dollar is creeping down. Someone my still expect oil to tank one last time.

What we don't realize is that while the aggregate data is down, declines in income are not spread anywhere near evenly across the population. More than half of us may not have seen any change in income. But, nearly everyone is much more conservative with their money than in the past. New savings is driving the markets. The Fed is bypassing the banks by buying federal debt and bad mortgage paper at multiples of its real value. This money goes straight into circulation. Mish can fret over his zombie banks all he wants. They don't have to lend. People aren't buying houses or cars or vacations with their newly minted cheap money. They are buying stocks and bonds. DJIA 12.5k by April.


Coal Guy

Greg T. Jeffers said...

I remember all too well your take, and so far you have been dead on. Congrats.

More on that soon.

Greg T. Jeffers said...

BTW, I AM expecting one more Oil price decline - or should I say "was"?

The inventory declines during the bloody "shoulder season" do not argue for a big decline in the price.

kathy said...

I don't mean to sound stupid but is it enough for a company to sell stocks to be successful? Don't they also have to sell a product? If the the consumer is not buying won't that mean stocks have to slide?

Greg T. Jeffers said...

Hi Kathy!

Not in the short term. In the short term stocks can move up and down due to "multiple expansion" and "multiple contraction", industry terms for increasing or contracting P/E ratios based on changes in the price of the stock - NOT changes in earnings.

If too much money is made available by the central bank stocks, bonds, gold, real estate can ALL go up at the same time - this is monetary inflation, something the Fed is doing at the moment (and more successfully than I thought likely).

Also, stocks might have been too deeply discounted in March - though I would not have thought so - and are now correcting higher.

Or, with interest rates very low, and rents falling, there is little competition for stocks...

Or maybe earnings ARE expanding...

or any combination of these circumstances

Anonymous said...

This video perfectly explains what is happening in the markets...

The party hasn't even started :)

bureaucrat said...

I am still waiting for the end of this "sucker's rally." And as to who is buying all this stock and bidding up these prices, nobody knows for sure, but when the stock markets increase by trillions in value while the money removed from the money markets is only a few hundred billion, it seems to take very little time to figure the Fed is goosing these stocks thru the banks, who are doing the actual buying. What is being bought mostly is a very small number of stocks and they are all financial. From a fundamentals perspective, this cannot go on forever. This all cannot help China forever either.

Anonymous said...

Thanks Greg,

Beginner's Luck!


The Fed is goosing everything it can, and there is a positive feedback effect. As asset values rise, the overall debt to equity ratio falls. There is again asset value to borrow against, and lending increases, creating new money that drives asset values and so on and so on and so on. This is the stuff of bubbles.

The first effects of monetary expansion are euphoric. Everything looks better. Business conditions improve, the markets rise. If overdone there are BAD side effects. If prices rise too rapidly, especially on consumable goods, and the value of money declines, interest rates rise. No one wants to get paid 2% interest on an investment as the value of the dollar declines 7%. Inflation has generally started at around two years out from the beginning of the monetary expansion.

High interest rates kill the markets. The value of older low yield bonds falls, and the stock market gets killed as money flows toward new high yield paper. Real estate values are depressed, because people buy more according to the payment that they can afford rather than the dollar value of the property.

The Fed then has two choices, either try to bring interest rates down by further expansion, which only forestalls disaster (as we are living through now), or to contract the money supply to cool the economy, and cause a recession.

My point to all this is, when the CPI or interest rates start to ramp, get the h&!! out of Dodge. The Fed is trying to create inflation. They are going to get it. Price inflation starts when demand starts bumping up against productive capacity. There is capacity to burn except in a few important commodities.


Coal Guy

Greg T. Jeffers said...

Col guy:

Was that a type in the last line? "are" instead of "aren't"?

In any event... it is true that there is excess capacity in EVERYTHING except a few commodities. It is also true that the US$ decline will cause import price inflation.

And sometimes beginners outperform pros because everything they "know" often works against them. I'll take "luck" any day.

Anonymous said...

Hi Greg,

They are going to get it but in some ugly ways. It won't be general price inflation. It will be in oil because it will be short as economic condition improve. Imported goods and food will rise as the dollar declines. They may buoy real estate a bit, until interest rates go up.

I think they would really like to create wage inflation. That remains to be seen. With no improvement in employment it will be hard to get. I don't know how they can create a labor shortage when the price of oil will kill any sizable economic expansion.

My longer term take on this is that the dollar will decline without wage inflation and our standard of living will continue to fall. I'd expect that since they want to create inflation to mitigate the debt load as well as just stimulate the economy, that they are likely to overshoot the mark and create a lot more dollars than we might expect. As the do this, they will depress interest rates and extend this run-up.

As you said in one of your posts, this is a great time to get out of equities before things go bad. I couldn't agree more. Up until now, I've followed the common wisdom and been a buy and hold kinda guy. It hasn't worked too well for me. I've got various 401k's etc that I'm preparing to move. Things don't look too rosy 6 months to a year out.


Coal Guy

bureaucrat said...

The inner pessimist in me looks at the cogs of the investment/economic industries and keeps seeing that we still are unwilling to entertain the possibility that cyclically, historically, bubbliciously, we may have indeed put ourselves into another depression .. not a Great depression, but perhaps something different, or even something worse. Debt, debt, unservicible debt everywhere you look. It is funny that no one wants to even say the word "Depression," cause the idea is so impossible to fathom. We prefer "Great Recession." People were thinking human beings in in the 1920s. Did they ever think it would get as bad as it did? And since they had a war to get them out of it (tho some would differ with that line of reasoning), what in the hell do we do if our world economy becomes that bad?

Anonymous said...

We eat shadow soup, like my dad did.