The rumor of hyperinflation is in the air again. We think it’s greatly exaggerated …
Why is this important? Because all the talk of a “bond bubble” is predicated on inflation … if it doesn’t materialize, there is no bond bubble. In fact, we do not think there is a bond bubble. The move in longer-term Treasuries is a natural reaction to the underlying weakness in the economy and ongoing outsized risk potential globally, i.e. the eurozone as the best single example.
Money doesn’t become money until it reaches real people who can use it to bid up real prices.
Operations by the Federal Reserve, including the start of the second round of quantitative easing (QE2), have increased bank reserves by approximately $1 trillion since the latter part of 2008. Virtually all of this gain is held in excess reserves at the Federal Reserve Banks earning very close to 10 basis points. In other words, the Fed has provided substantial new reserves to the banks and they have, in turn, deposited the funds back with the Fed.
Thus, all the handwringing and newsletter promotional scaremongering about the massive increase in the money supply, and using Milton Friedman’s quote as backup, i.e. inflation is always a monetary phenomenon, completely misses the point. It is not just about reserves created by monetary authorities; Friedman would be the first to say.
And what is interesting, is the fact that M2 in the US has been growing less than its historical long-term rate besides! According to Hoisington, M2 grew 3.1% in the last twelve months, yet the long-term average growth rate is 6.6%. After one factors in inflation, the real growth rate in M2 is even less. Thus, all that so-called money being provided isn’t showing up as money after all.
Once again, we only have to look to the best real-time experiment available to us to show a similar patter—Japan. They had zero interest rates for years and years. They poured a lot of money into the market to save morbid banks and business—sound familiar? But, just because it was available at very low interest rates didn’t mean it was stimulative. Japanese borrowers and businesses were overleveraged and in the process of liquidating that leverage, so the fact that they didn’t take that so-called new money was no matter.
US “official” Unemployment Rate
US consumers are also in deleveraging mode, so it will be quite difficult for the banking system to turn all those reserves into money even if they wanted to. Even if they could find enough quality borrowers—which they cannot now that lending standards have
been tightened and credit scores for most have fallen.
This we believe is why consumer credit growth is falling and housing prices will continue
to fall:
So what about soaring commodities prices? Doesn’t that prove inflation? Not
necessarily. It depends how rising commodities prices come about and how real people
react relative to their income or ability to fund higher prices.
Given relatively flat income and lack of access to credit, the impact of rising
commodities prices means the consumer shifts his spending from other, more discretionary goods, to those commodities that are a necessity, e.g. gasoline and heating oil. This shift in spending means no additional money was thrown into the market; it simply shifted money to commodities producers.
This is not to suggest there isn’t real demand for commodities or very big speculative interest. And as we have seen before, speculative fervor can move prices quite far, e.g. oil at $147 per barrel. As noted by Hoisington: commodities loans can be had for around 1% or less, by the big players. Accordingly, “this encourages speculative buying of commodities for inventory, thereby causing food and fuel price increases.”
Remember the fraud of Peak Oil? That move to $147 in the price of oil didn’t exactly lead to hyperinflation or a popping of the “bond bubble” then did it? Instead it set the stage for another major bout of global deflation.
Two more things that are lingering on the background that could have a dramatic impact on the intensity of the lingering deflation:
1) Stagnant growth and debt liquidation in the eurozone will be deflationary.
2) A realization that China cannot support the credit now sloshing around in its market; creating speculative bubbles here and there thanks to the Roach Motel impact, i.e. credit can get in but not get out, would be another major kicker.
Interesting that as I pen this missive this morning the dollar is getting hammered and love and joy have returned to the risk appetite trade. The S&P seems ready to go to 1,300 and copper will continue to make new highs as far as the eye can see. Oil is clearly on its way to $100 per barrel, at least. All plausible given the numbers China keeps posting.
All support the inflation story. We never want to say never. But we think not. Because if there is an inflation problem here, imagine what China is dealing with. Inflation creates lots of social unrest in emerging markets. From former Economist magazine editor, Bill Emmott, from his book 20:21 Vision:
“But it is worth recalling that in 1989 a demonstration by a few thousand students in Tiananmen Square in Beijing was considered to be such a threat to the regime that troops were sent in to killed hundreds of the students. That demonstration had economic troubles at its root as rising inflation [now a credit bubble with rising inflation to support the lopsided growth model] coincided with an economic pause. Think what impact the existence of many millions of unemployed could have, if they came to expect their plight to last.”
Thus, there are reasons, right alongside the global benefits of roaring growth, why China’s great wall of stimulus could come down.
From Vitaliy N. Katsenelson, CFA, Investment Management Associates; when it comes to
stimulus, “China knows stimulus” no matter how much they bash the west for, well,
stimulus spending. It is fresh!
Hmmm…construction projects…constructions projects…what did we just hear about
that? Oh yeah…
According to Jim Chanos, from his recent appearance on CNBC—the major “lonely”
China bear hedge fund manager–60% of China’s GDP flows from construction.
Can you say “Chinese Ghost Towns”?
We are told by many we continue to miss the point. China is booming and demand there is insatiable. But we see the ghost towns and look at the numbers. Demand for housing is huge in China, we would agree. But can those workers afford the stuff being built—stuff seemingly built to attract international and domestic spec money to provide for real housing needs locally?
This is the crux of our concern about China, from what we wrote in our latest monthly research back in mid-November piece to our Members:
Massive misallocation of capital – years of suppressed interest rates and capital controls to maintain its currency peg with the US dollar has led to massive over supply and malinvestment throughout the country
This is inflationary now. No doubt. But we’ve seen this movie many times before over the course of economic history. We never know when it ends, but it usually ends badly. And that bad ending has usually proved deflationary.
