Posts Tagged ‘inflation’

This has been an interesting debate to watch.  Until about a few months ago, inflation was the “in” thing.  The notion has been that since the Government has been printing money and flooding the economy with stimulus inflation would be created. 

My stance has been all along that we will not see inflation for a long time for a few important reasons.  First deflation is often the result of too much debt in the system.  Second, the government can print all the money it wants and not create inflation because the money that is printed is going to absorb losses in the system.  The key is that money is not circulating. 

If you introduce money into the economy and that money circulates through buying and selling of goods and services and is being lent out, you can definitely create inflation.  That is not happening.  That circulation of money is measured by the velocity of money.  If money is circulating at a high rate, we have expanding velocity.  Today we have been watching velocity contract instead of expand.  As the losses on debt continue to mount, it will be tough to expand the velocity of money.  We are on the toxic path of debt.

All of the sudden, it is as if economists are starting to recognize deflation.  Now the “in” word is deflation and not inflation.

Consider the definition of deflation.  Deflation is a decline in general price levels, often caused by a reduction in the supply of money or credit. Deflation can also be brought about by direct contractions in spending, either in the form of a reduction in government spending, personal spending or investment spending. Deflation has often had the side effect of increasing unemployment in an economy, since the process often leads to a lower level of demand in the economy. (Source: Wikipedia)

This is pretty much what we are seeing.   Ironically, during a period of deflation, the dollar is actually strong and gold weakens.  We are also seeing that trend. 

The Federal Reserve Board is now acknowledging we might have a deflationary problem.  Ben Bernanke is regarded as an expert on deflation.  Expert or not, it is happening on his watch. Inflation is something the Federal Reserve Board can tackle head on.  Think of deflation as aggressive cancer whose only cure is experimental medicine. 

This last Federal Reserve Board meeting illustrates how they are shooting in the dark.  In fact, some economists fear that these new steps they are taking could actually backfire and make the situation worse.

Even more amazing is that we could pump 100’s of billions of dollars into the system and almost 2 years later have the same problems on a much larger scale.  As I have said many times before, the politicians and the Federal Reserve Board are useless in this scenario. 

The only solution to our economic mess is letting the system detoxify on its own allowing consumers and businesses to work through it.  In that process you stop creating more debt and allow the losses to occur.  You support small business in an attempt to rebuild what has been destroyed. 

Unfortunately, we are getting the exact opposite out of Washington.

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Bloomberg had an article posted today entitled – Bond Traders Declare Inflation Dead after Yields Fall!  The article surmises that interest rates are low and well contained.  One trader states that he is not concerned at all about rising interest rates.  He doesn’t think that rising interest rates will be a threat.

I believe that interest rates will rise for one simple reason.  Let me show you an illustration of something that ran in the Chicago Tribune.

(related image) 

Debt will probably be the reason that interest rates go up.  If you have been staying up on the news, you know that Greece and many of the other European Union countries are in financial trouble.  Greece, in particular, needs to borrow money or are seeking a bail-out just so they can make their debt payments to their creditors.   So if you are going to lend money to someone in trouble, shouldn’t you get rewarded with higher interest rates for taking the risk?  When Greece issues bonds (read: borrows money), they are forced to pay higher interest rates because they represent a risk.  I think that we will start to see the same thing in this country.  In fact, I think that we already are seeing this occur.  At some point, investors are going to demand much higher interest rates on US government bonds which forces interest rates to rise.  One other point to make about the article is that rising interest rates does not automatically equate to inflation.  We need prices to go up all across the board for inflation which brings me to the title of this piece.

Inflation would be a welcome sign.  The opposite of inflation is deflation.  That is what Japan has been mired in for decades and what the US went through in the 30’s.  I believe that is what we face today. Unusually high levels of debt create deflation.  So, once again, we come full circle to this enormous debt problem in America.  Our politicians can pretend it is not there.  We can also think of it as our children’s problems.  In reality, it is driving force behind all financial problems in this country.

Low Volume

Will Deener wrote an article in the Dallas Morning News this morning debunking the views of those of us who are bearish.  He quotes a trader that states the low volume in the stock market is actually a bullish indicator.  He says that you want to buy stocks when no one wants them.  I don’t think that I would go this far.  There is something else that usually occurs when the volume is this low.  You typically see low volume when you are getting to the end of a bull market run.  Further, investors are unusually spooked right now about the stock market.  I don’t think that this kind of fear is a good thing.

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There is an intense debate on Wall Street about whether or not we are heading towards a massive inflationary problem or if we are stuck in a deflationary problem.  Inflation is when prices go up and deflation is when prices go down.

If you are investing money, it is going to be important to get this one right.  So many of the talking heads on CNBC are declaring that we are heading towards extreme inflation.  They cite that the printing of money by the government is causing it.   They also point to this “incredible” rebound we are seeing in the economy.

If you will bear with me, I need to put the KOOL-AID down so that I am not tempted to drink it.  On the surface, it is inflationary when the Government prints enormous amounts of money.  However, the story goes well beyond the printing of money.  I regard these financial hosts as pretty smart people.  I often wonder if these hosts are all told to always be positive no matter what?  After all, they do work for CNBC, which is owned by GE, a publically traded company. 

Here is the evidence of deflation:

The velocity of money – Dig out your economics book. The velocity of money measures the circulation of money throughout the economy.  The velocity of money would need to be running pretty high to potentially create inflation.  Currently it is very low primarily because banks aren’t lending money and consumers aren’t spending money.

A world overloaded with debt – Debt in itself is deflationary.  Deflation is brought on by a debt crisis. 

The money supply – The money supply has been decreasing and not increasing. You would need to see the money supply expanding at a great pace to see inflation.  

The CPI and the PPI – The PPI or Producers Price Index shows whether or not the prices or increasing or decreasing at the producers level.  In other words, are the widgets getting more or less expensive to make?  The CPI or consumer price index shows what is happening to consumer prices. Are they going up (inflationary) or down (deflationary)? 

The latest PPI numbers showed an increase in prices at the consumer level.  When that happens, typically those higher costs get passed onto the consumer and are reflected in the CPI number.  However, the CPI numbers released on Friday showed the first drop in 27 years.  That tells me that companies are getting hit with higher costs but are not able to pass them on because the consumer is so strapped.  That keeps a lid on prices.  In fact, companies are dropping prices to get consumers to buy items.  That in itself is deflationary.

To be fair, the CPI minus energy and food costs decreased.  Yes we depend on energy and food which have been going up.  I think that net effect is clearly deflationary.     

In short, the reason that the printing of money is not causing inflation is simply because the printed money is not circulating.  It is absorbing losses of all kinds due to the effects of the debt crisis.  Until you get massive circulation which would show up in the above indicators, I think that we are stuck with deflation.  Plus you better hope that it doesn’t turn into inflation.  That would force the Federal Reserve Board to start aggressively raising rates which would easily throw us into a double dip recession if we aren’t already heading that way.

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A client of mine forwards me an e-mail from time to time that he receives from another financial advisor.  These e-mails are typically very positive on the state of the market.  I also find that they are filled with what I would refer to as market myths.  I thought I would share some of these with you.

(1)  Companies are showing strong profit reports – thus we are definitely in a strong recovery

Companies have slashed their expenses (and people) to the core.  It doesn’t take much to report strong earnings when you drastically cut your expenses.  Much of what is reported has nothing to do with actual profit growth and has more to do with the ability to cut expenses. 

(2)      Weekly jobless claims have been falling – that is a good sign

Every Thursday the government reports how many new people filed for unemployment benefits.  Over the course of the last few months those weekly numbers have marginally improved.   Does that mean that things are getting better in the job market?  I don’t think that the weekly number means much of anything at this point.  First, they should be decreasing just because companies have cut employment back just about as aggressively as they can afford to and still run a business.   Second, I would argue that the unemployment claims numbers still running this high is a negative.  As I pointed out, they should be on the decline.   Recovery in the jobs market comes as soon as companies start aggressively hiring.  This is something that we are not seeing.

(3)    The Price of Gold is signaling that we are heading for inflation

This is not necessarily true when there is nothing there to produce inflation.  Yes, we are printing money by the truckloads in this country.  However, that money is not being used to boost consumer purchases or being put together as new consumer loans.  All of that printed money is being used to absorb massive losses that would ordinarily not be there.  Remember that gold is a psychologically driven investment.  It does not have any value nor does it produce anything.  It is not a currency.  It goes up or down because people think that it should.  There is nothing to back up the price of gold.  The price of gold didn’t start going up until the dollar started having problems.  Ultimately, the government will do whatever it has to do to shore up the dollar.  However, longer-term, the dollar is in real trouble.

Economists declare that the recession is over – When the majority of economists thing one way, typically the minority is right.  Economists as a collective body rarely make the right forecast. 

This Week

It is all about earning, earnings, and more earnings.  It is very hard to predict how the market will react to earnings reports.  My guess is that companies will need flawless reports and near perfect outlooks for the near-term. Anything other than a show of strength might be tough for the market.  The stock market has very large expectations right now.   One thing for sure – this should make for an interesting week.

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Wall Street (which drives me crazy) calls even the smallest bit of good news “green shoots.”  The analogy is that grass starts to grow in the form of a “green shoot.”  Well, I have many “green shoots” in my yard right now.  Unfortunately, these green shoots are weeds more than anything.  John Mauldin made a very good observation in his latest writing.  He said:

“My premise for uttering the heresy “This Time It’s Different*” is that the fundamental nature of the economic landscape has so changed that comparisons with post-WWII recoveries is at best problematical and at worst misleading.”

His point is that Wall Street is looking at this recession through the lens of past recessions since WWII.  It is like comparing apples to oranges when you think of what makes up the problems that we face today.  Last week, the S&P cut their investment ratings on 22 banks.  Banks depend on strong investment ratings so that they can attract investor money.  The Consumer Price Index saw its largest drop since 1950.  Once again, it looks a lot like deflation more than inflation.  The reality is that there is a higher probability that we are in the throws of a deflationary problem which is something that only time can solve.  The problem with the weeds in my yard is that I cannot do anything about them unless I want brown spots all over my yard.  I will have to wait until next year and make sure that they don’t come back.  This is unlike any recession since the 1930’s. 

This week will have some interesting events.  The Federal Reserve Board meeting, that always makes for an interesting day.  The Treasury is set to sell billions of dollars of Government Bonds on the open market.  It will be interesting to see how interest rates hold up.  Once again, a rising interest rate environment is the last thing that a debt laden economy can handle.

As I write, the S&P 500 is below a critical price level of 900.  If the market were to close below that level, we would want to watch the next couple of days very carefully.  Once again, we want to evaluate whether this stock market rally is the beginning of a new bull market or nothing more than a bear market rally.  It is my view that this is nothing more than a bear market rally.  Thus, you want to be monitoring your risk very closely right now.  I will update more frequently this week as it warrants.

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I typically post in the morning and write about the prior day’s market action in addition to the morning economic news.  I am writing this Tuesday night because I am speaking at a conference in Fort Worth Wednesday morning, which will fill most of my morning.


So, Wednesday we will get another look at inflation numbers with the Consumer Price Index report.  Tuesday we saw the Producer Price Report numbers.  I wrote about them in my blog.  The Consumer Price Index tells what is happening to prices (rising or falling) at the consumer level.  It will be interesting to see if the CPI numbers look as deflationary as the Producers Price Report.


Tuesday, it wasn’t a very pretty day on Wall Street.  The big questions are:


–  Is this the start of a new bull market and the bear market is over? 

–  Is this just a bear market rally?

–  If it is a bear market rally, when will it be done and how bad will the next part of the bear market be for investors?


Daily price levels give us clues about the future direction of the market.  Remember price levels are like road markers.  They tell us if we are headed in the right direction or not.   My opinion is that we are in a bear market rally and this bear market rally is nearing the end.


We are always looking at the CLOSING price level of the S&P 500.  Tuesday the S&P 500 closed on an important price level of 841.  It will be interesting to see what happens from here.  We might be getting ready to go down to 800 and “test” that price level.  If the market can stay above that level, that would be a positive sign.  If not, look out below.  We will have to wait to see what Wednesday brings.



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I appreciate your helpfulness & knowledge. I find it puzzling that you don’t put more emphasis on hard assets in this environment. Check out the Tocqueville funds 4 portfolios from Jan first & compare! Also, gold has been a winner each year for the last 8 to 9 years & was the only asset class to post positive returns last year!

I realize that  Gold Bugs will strongly disagree with my opinion.  Hard assets are a good investment.  However, ultimately not in this environment.  As deflation continues to set in, gold will have a tough time continuing too appreciate. Gold does not historically do well in deflationary environments.  So, I see a few scenarios for gold.  First, Gold could go on a rampage for a few months and then go through a sell off like oil did last year or Gold could top here around 1000 (putting in a double top) and then start a decline over the balance of the year. 
However, longer-term we have a major inflation problem to deal with and I think that gold will be a great investment.  There is a little to much hype right now (much like oil last year) that indicates to me that we are seeing somewhat of a bubble atmosphere.  If gold does take off from here, I really do feel that we will see a similiar situation as oil.  When something seems like a slamdunk and every other commercial on cable tv is peddling gold, then there is a red flag.
Here is a good article on gold and deflation – http://www.elliottwave.com/deflation-gold-relationship.aspx
Actually hard assets wasn’t the only asset class to do well last year.  Bear market mutual funds did incredible last year.  This is an asset class that doesn’t get much press.
Keep the Faith

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