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2009.11.16
Indeflation Revisited
Some month previous I posted my thoughts relating to the possibility of inflation and deflation occurring at the same time. I termed this state of economy as "indeflation". I have been puzzling over this for several years as I believe that this is exactly the situation that we find ourselves in today. How can this be so? How can you possibly have both inflation and deflation occurring at the same time? Is this not an oxymoron?
I have since come to the realization that we are experiencing inflation in real capital while experiencing deflation in financial capital. What exactly does this mean? First let us define these terms. I have previously defined inflation as an increase in money and credit relative to the available goods and services in the economy and deflation as the decrease in money and credit relative to available goods and services (see my previous post on "indeflation"). So what exactly do I mean by "capital"? Capital is the entirety of inputs required to manufacture goods or provide services demanded by consumers. These inputs can be subdivided into: 1. "real capital" - the physical inputs required to manufacture goods or provide services (such as tools, machinery and buildings); and 2. "financial capital" - commonly referred to as money but would include any commodity used to purchase the "real capital" required to produce demanded goods and services (note that this would include what we commonly think of as "credit").
My belief is that we are currently experiencing deflation in financial capital while at the same time experiencing inflation in real capital. The deflation in financial capital can be readily seen in the declining total system "money and credit" (consumer, corporate and government). The reason that the Federal Reserve has more than doubled its monetary base in the past year or so was a futile attempt to counteract the fall (reduction) in total system credit. The Fed has not yet succeeded to do this nor do I believe it will in the future. (At least not until the total amount of debt in the economy is reduced to the point where debt can be reasonably expected to be repaid with available income over a reasonable period of time relative to the life of the assets being financed.) On the other hand we have seen (and I believe we will continue to see) most essential (and scarce) commodities increase in price ... which I define as "real capital inflation".
Why then are we seeing "financial capital" deflation at the same time as "real capital" inflation? I believe that it is due to the devaluation of what we have been conditioned to regard as "money". Our society does not distinguish between money, credit and currency. These terms are generally used interchangeably but in fact have very different meanings. We commonly refer to all of these terms as "money". In fact, fiat money only holds value as long as the majority of people have faith in its value. "Money" is nothing more than any commodity that has increasing marginal utility. I believe that society is losing its faith in all fiat currencies as money. As a result, we are turning to "real capital" as an alternative to fiat money. Therefore "real capital" such as: precious metals (primarily gold and silver); oil; other forms of energy such as natural gas and renewable energy; and even other essential commodities such as grain, poultry and cattle, are increasingly serving a monetary role. Fiat currencies may continue to serve the monetary function of a means of exchange (at least for a while) but these other essential "real capital" forms will serve the monetary function of a store of wealth.
So bottom line is get used to a paradigm shift in your concept of "money". Money has two distinct functions: 1. a means of exchange; and 2. a store of wealth. It is entirely possible to see deflation in the former while at the same time seeing inflation of the latter (or vice versa).
Gerry
21:57 Posted in Finance | Permalink | Comments (1) | Email this | Tags: indeflation, inflation, deflation, gold, silver, oil, real capital, financial capital, money, credit, commodities, economics, capital
2009.11.13
Changing focus
I know ... I haven't posted in some time now. Not since August 9. I haven't changed my mind about the global economic situation. I still believe that we are in the middle of a severe bear market but we have been in a bear market rally (a temporary reprieve) since the beginning of March 2009. In short, I believe that the world's major stock markets will see new lows before seeing new highs. (For example the US S&P 500 index will fall below 670 before it breaks its all-time high of 1550). The reason that I am so confident of this prediction is that none of the world governments or central banks have done anything to lead us out of this mess. If anything their actions have only served to make things worse. The market can be counter-intuitive for very long periods but eventually fundamentals will prevail. Simply put, we need to de-lever and eliminate a substantial amount of world debt (through debt pay downs or through outright defaults) before our fiat monetary systems can become healthy and functional again. The only thing that we can do to prepare ourselves for this is to get our own individual finances in order ... pay down debt and reduce discretionary expenses ... in other words increase savings.
On that note, I want to say that Dawn and I will be returning to Antigua at the end of November. We will spend a few weeks making repairs to our 36 foot sailing sloop Chinook Arch before sailing to nearby islands over the winter months. As a result the focus of this blog will shift from commenting on global economic issues to providing a journal of our days in the Caribbean aboard Chinook Arch.
Gerry
22:36 Posted in Finance | Permalink | Comments (0) | Email this | Tags: caribbean, antigua, chinook arch, economics, deflation, bear markets, bear market rally, central banks, s&p500
2009.08.09
Is the BIS predicting the Great Depression II?
Is the Bank for International Settlements predicting another, even deeper, Great Depression? Please read the following well researched article.
Gerry
14:14 Posted in Finance | Permalink | Comments (0) | Email this | Tags: bank for international settlements, great depression, great depression ii, bis
2009.07.20
Is the recession finally over?
I think not. Many statistics published by the US government have had their methodologies changed over the years and therefore produce unreliable comparisons over the long term. However, payroll withholding receipts are difficult if not impossible to fudge or spin. Take a look at this graph!
Note that the 3rd quarter of 2009 is based on the first 17 days of July and will change as the quarter progresses (the chart is updated daily). The previous data points however are historical and will not be subject to adjustment.
Gerry
18:16 Posted in Finance | Permalink | Comments (1) | Email this | Tags: payroll withholding, recession, us government statistics
2009.07.08
Will China be the next bubble to pop?
Ok ... I know that it has been a long time since my last post but quite frankly I have not found much that I wanted to write about. Over the past few months all we have heard in the financial press has been about so called "green shoots" popping up all over the financial landscape. These clowns would have you believe that all is back to "normal" and it is only a matter of weeks before the previous high of 1550 on the S&P 500 is reached once more. I have just been sitting back and waiting for signs that things are not quite so rosy and that we may see another shock to the system.
China (of all places) may be the next bubble to pop which would send shock waves throughout the financial world. The Shanghai Stock Exchange Composite Index (SSEC) has already fallen from a high of 6000 in October 2007 to a low of about 1500 in November 2008 for a drop of 4500 or 75%. Since then it has regained 33% of its loss to close above 3000 ... a gain of 100% in only 8 months time. Not only is their stock market on a tear but there seems to be a massive bubble in real estate as well. The China Daily reports that house prices in Beijing are now increasing at 6.5% per week (not a misprint) after nationwide property prices fell for seven straight months . See the MarketWatch report at http://www.marketwatch.com/story/beijing-central-property...
Also the BBC news is reporting that China has suffered an embarrassing fail in its recent one year government bond offering of 28 billion Yuan (US$ 4.1). This is a small amount and was only yielding 1.06% but a fail in a government bond issue is not something that you read about every day. China was apparently trying to put the breaks on the economy (lightly) by trying to soak up this small amount of Yuan. The fact that the issue failed to be fully subscribed indicates that the market was unhappy with the interest yield. China cannot afford to raise interest rates in this worldwide economic crisis. If it does it will send shock waves throughout the world financial community. So far this is just a pimple on the backside of the ruling oligarchy in China but it could easily morph into a festering boil. Keep a close watch on this one.
Read the BBC article at http://news.bbc.co.uk/2/hi/business/8139902.stm
Gerry
16:16 Posted in Finance | Permalink | Comments (1) | Email this | Tags: china, yuan, bubble, government bond, housing, ssec
2009.06.11
Nervous markets?
The US stock markets have been moving sideways since the beginning of the month while bond yields have been rising (rather spectacularly in the case of the 2 yr US Treasury). So what is happening? The bond traders are skittish while the stock market traders are still buying the BS about "green shoots" sprouting up all over the economic landscape. So who is right? My money is on the bond traders. I predict that we will see a fairly drastic fall in stock prices soon ... certainly before the end of the summer. If stock traders don't come to the realization on their own that stock prices are overvalued the higher rates in the bond market and mortgage market will do it for them. Corporate earnings will fall due to the rising rates and stock prices are ultimately based on earnings expectations which are set to fall. This recession is still far from over.
Stay vigilant and be wary of stock brokers and financial media types talking their book.
Gerry
17:30 Posted in Finance | Permalink | Comments (0) | Email this | Tags: stock markets, stock prices, bond prices, recession, mortgage rates
2009.06.03
A race to the bottom?
What happened today in the foreign exchange (Fx) markets? The last I looked the Canadian dollar fell 2.53% to US$ 0.9022, the British pound fell 1.92% to US$ 1.6267 and the Euro fell 1.3% to US$ 1.4199. In "normal" times these extreme moves would not occur in a month let alone one day. There was no apparent fundamental reasons for this to occur today. Sure crude oil fell $2.59 to $65.96/bbl which may have some negative impact on the Loonie but why would the BP or Euro fall as well? The UK is a net importer of crude oil as is Europe. Surely they would benefit (though likely not as much as much as the US does) when the price of oil falls. It is apparent to me that this was a co-ordinated hatchet job by the 2 countries and the Euro zone (along with lot of help from Uncle Sam) to sell their own currencies and buy the US$. As a result the US dollar index rose 0.96 today to 79.49 (this a basket of currencies which includes the 3 currencies mentioned above as well as the Japan Yen and the Swiss Franc).
Why would a central bank intentionally manipulate its currency downward? Because they are worried that their exports will suffer if their currency strengthens too much (and too fast) against their major trading partners. So what we saw today was an attempt to debase three major currencies in order to make the sick US$ look better. This is akin to a person taking low doses of poison in order to make a friend who has cancer feel better about his condition. Of course it doesn't help either party and in the end may prove fatal for both.
The US$ index had fallen quite steadily since its high of 120 in January 2002 to its low of 70.70 on March 17 2008. From there it had a nice bear market rally to 89.62 on March 4 of this year whereupon it started to resume its long term decline to 78.33 touched yesterday until the central banks started manipulating the currency (my belief, not fact). This of course is all a waste of money as manipulations of this kind can only have a short term effect until the market decides to resume its long term trend. Central banks cannot control the Fx market with their manipulations for long.
The US is petrified of seeing their currency retest the recent low of 77.69 reached on December 18 2008 since it is likely to fail. Once this level is breached it will likely fall quickly to test the 75.89 handle reached September 23 and should that fail it will likely fall all the way to its all-time low of 70.70 on March 17 2008. After that we are in unchartered territory folks so anything can happen. If the US does not get its fiscal house in order by drastically reducing spending and start to grow its GDP to levels at least as high as those projected (or rather hoped for) by the Obama administration over the next 5 years the world will completely lose confidence in the US$. This would not be a good thing for world trade and hence our standard of living since the US$ is by far the world's major reserve currency.
When will the Obama administration step up and do the right thing? It is pointless to keep playing these confidence games in an attempt to convince (fool) the public that the economy and monetary policy are doing well and are under control of the supposedly omnipotent and omniscient government. Debt must be reduced, not increased by the unimaginable amounts being attempted by the US government in a futile effort to re-inflate the already burst housing and stock bubbles that they created over the past decade or more. There is not much time left to change course. Government spending must be reduced and brought under control quickly. In addition, taxes must increase. I know that this flies in the face of neo-Keynesian thought but we have come to a crossroads (or Morton's fork) here. Either we allow the markets to deflate quickly, take the pain and start to rebuild a stronger economy that is not centrally controlled by governments and central banks or we will experience the unbelievable pain of hyperinflation as all world fiat currencies implode. Neither choice is desirable but one will be taken whether intentionally or not. I prefer the deflationary route as the lesser (just barely) of two evils.
As Yogi Berra once said: "When you come to a fork in the road ... take it."
Gerry
15:40 Posted in Finance | Permalink | Comments (0) | Email this | Tags: obama, canadian dollar, british pound, euro, us dollar, currency manipulation, central banks, morton's fork, yogi berra
2009.05.31
Chosing the right asset class.
In my last post, "What is money?" (http://chinookarch.blogspirit.com/archive/2009/05/29/what...) I referenced the work of Paul van Eeden which shows us that inflation of the "Actual Money Supply" (AMS) has been increasing at a rate of approximately 8% per year since 2006 and appears to be maintaining this high growth rate. If this is true, where is all the new money going? We have seen stock prices rise by more than 35% since their recent bottom of March 6, 2009 so some people would argue that this new money is finding its way there but I doubt it. However, this is a very impressive increase over a period of less than 3 months. I believe that most of the new money is being used to pay down existing debt. We have been bombarded with messages in the mainstream media that the "bottom in stock prices is in" as witnessed by "green shoots" popping up all over the economic and financial landscape. Of course the people who are telling us this are the very same people who completely missed predicting the stock market crash that occured from October 2007 to February 2009. Are they right? Can we expect that all this inflation (or printing of money) by the Fed and other world central banks will continue to find its way into the stock market? Don't bet on it.
Once you answer the question, "Do we see inflation or deflation of the money supply over our planning horizon?", the next question to ask is , "How can I protect my wealth?" In order to answer this you must know what your alternatives are. What are the asset classes in which you can invest your money until you need it for consumption purposes at a later date (such as for retirement or the education of a child)? You only have about 6 choices: stocks, bonds, real estate, commodities, money (currencies) or collectibles.
Lets dispose of the easy ones first. Unless you are an expert in some type of collectibles such as rare paintings or antique cars, you should stay away from collectibles. I would argue that even if you do have this specialized knowledge now is not the time to invest in collectibles as they tend to be illiquid (difficult to sell when you need the money).
What about real estate? If you need a place to live and do not want the uncertainties and hassles of having to move every few years associated with renting then this might make sense. As an investment however this is not a good idea. Typically the asset that created the previous bubble is the last one to emerge after the bust. Take the tech bubble for instance. From the peak of the tech bubble early 2000, the NASDAQ fell over 80% to its ultimate bottom in the fall of 2002. In the six and a half years since reaching this bottom the NASDQ has recovered over 40% but the index still remains 70% below its high reached in March 2000. Not a very good investment if you got got in at the high and held until today. I believe that the housing market will see similar results. We may see a bottom sometime in 2011 but barring a hyperinflationary environment we are unlikely to see the high prices of 2006 for a decade or more. High inventories of unsold homes and high interest rates will see to that.
What about stocks and bonds? If I am right, stock prices have not yet hit bottom. The increasing stock prices that we are currently experiencing is reflective of a bear market rally that will be reversed sometime within the next 3 months. In fact, I expect that the Dow will eventually fall below 5000 before we see a true bottom. Valuations are still too high and corporate profits will likely fall even further as the recession deepens. We may even see a double-dip recession where we fall back into recession only a few months after emerging from the current recession. There are many reasons for this prediction but let me just summarize by saying that the problems that caused the financial crisis to occur are still with us and are possibly getting worse. The central banks and financial oligarchs that got us into this mess are trying to reinflate the bubble with even more debt. This very much like a drunk trying to drink himself sober. It is axiomatic that the solution to a problem cannot be to choose the same alternative that caused the problem to occur in the first place. As for bonds, interest rates will have to go considerably higher in order to attract the investment needed by the US Treasury to finance its massive deficits projected over the next decade. Higher interest rates mean a fall in bond prices so bonds are not a reasonable asset choice in the foreseeable future.
That only leaves us with money and commodities. This is where I would suggest you invest over the next several years. Say 40% cash and 60% commodities (or 50/50 if you are more conservative). Money or cash in the form of insured bank deposits or hard currency will be an attractive alternative to the losses otherwise incurred by those investing in stocks and bonds. It will also be good to have cash to invest in some cheap stocks and/or bonds when the true bottom is finally reached. It may be best to hedge your inflation risk by investing in several currencies at the same time. I consider gold bullion to be more like money than a commodity so I would include it in this asset class but even if you see it as a commodity you should carry 10 to 20% of your portfolio in gold bullion as insurance against both inflation and a total collapse of the fiat currencies that you hold.
What commodities should you invest in? I would choose those commodities that are considered essential needs. I include energy and food in this category. Oil, natural gas, grains, uranium as well as beef and pork should do well over the next several years. Luckily there are numerous ETFs (exchange traded funds that are basically like mutual funds but trade like stocks) that you can use as investment vehicles. You can get the name of some of these from your broker or just search the internet for the commodity ETF that you wish to invest in. Also silver bullion (in the form of bullion bars and coins) can be held in your safe deposit box as a good hedge against inflation. I treat silver bullion as a commodity since it is more like an industrial commodity than a monetary metal. I would not recommend investing in the ETFs of base metals or stocks of base metal producers. It is likely that world trade will be depressed for several years so these commodities will not see the increases that are likely to be seen in oil and gas for example.
Bottom line is that it is time to get very defensive in your investment portfolio if you have not already done so. Start by paying down debt and reducing your consumption in order to increase savings. I have been preaching this to my family and friends for several years now and it is not yet time to let down your guard. Do not chase higher returns ... they will be elusive and short lived. Such a strategy will more often than not result in losses as gains. Be very patient and be satisfied with protecting the wealth you have already accumulated. Remember that over the next several years return "of" investment will be more important than return "on" investment.
20:28 Posted in Finance | Permalink | Comments (0) | Email this | Tags: investment class, money, stocks bonds, real estate, commodities, collectibles, financial crisis
2009.05.28
What is money?
What is money and what is meant by inflation of the money supply? How can we measure inflation? You will get many different answers from different economists as to how to measure money: M0; M1; M2; M3; MZM; and TMS. I believe that the last one mentioned (TMS or True Money Supply) is the correct measure. It was proposed by the late Murray Rothbard, an economist of the Austrian school of economic thought. Unfortunately no government agency measures TMS but Paul van Eeden has developed an approximation of TMS for the US which he refers to as Actual Money Supply (AMS). You can find out what real money is by reading his article on the subject which is short and easy to understand at http://www.paulvaneeden.com/The.Actual.Money.Supply. He has updated the graph of monetary inflation to April 2009 at http://www.paulvaneeden.com/Actual.Money.Supply.
This is all well and good and it helps us to understand what money really is but how can we use this information to make sensible investment decisions? I will address this question in my next post.
Gerry
21:23 Posted in Finance | Permalink | Comments (0) | Email this | Tags: m0, m1, m2, m3.tms, ams, murray rothbard, paul van eeden
Is the worst yet to come?
14:46 Posted in Finance | Permalink | Comments (0) | Email this