I will start with the fact that I am not the coiner of the term Biflation. According to wikipedia, credit must be given to Dr. F Osbourne Brown though I doubt he was the first to think of the idea either. I belive we are in an economic environment where we are witnessing both inflation and deflation across separate asset classes. If my expectations are correct, we will see rise in commodity prices along side of a collapse debt based assets. Ensentially, sell your house and buy gold, energy and ags.
The bottom line is that everything we know about housing, the stock market and the economy as a whole is, for all intents and purposes, dead wrong. Mainstream media, or MSM as we will refer to it, has been cheering on the stock market and everything else done by the FED, central banks and other powers that be. MSM does not want the individual investor/homebuyer/employed person to realize this. Why?
Were the average Joe to wake up and think: what the hell am I doing loaded up to gills on mutual funds and/or stock index tracking funds and begin to sell, it could have devastating effects on the stock market. Note I use the term stock market not economy here. The stock market carries a very interesting role. It is perhaps the worst, most lagging, indicator of economic performance or solvency, but it is the one thing that the average person uses as a gauge of the health of the US economy. I hear this all the time: I saw the DOW was up 80 pts today, things must be good. Let’s take for example the September 3rd market rally as an example. We saw a big move higher in US stocks. Underscoring the run up in prices was the stronger than expected monthly Non Farm Payrolls number. Possibly the biggest report we see on a monthly basis. Now the report showed a loss of 54,000 jobs yet it was perceived as a positive report. Why? Because the market analyst were expecting the report to disclose near 100,000 jobs lost. So yes, it is relatively better, and yes, employment is a very lagging indicator and slow to shift trend, but the point I am trying to make is that we have now reached a time where bad news is expected, horrible news is shrugged off and slightly less bad news is fucking amazing and we have to buy everything…right now. That’s what happens on an almost daily basis. Here, in the trading world, we call it the risk on risk off trade. Some days you want to be a buyer, some days a seller. It often doesn’t matter much what stock or commodity you buy or sell. Stock correlation is at astounding highs so it almost makes more sense to trade and index the SPY over trying to pick the right stock to invest in. (if you don’t follow me on that one, I mean to say that most stocks are moving in tandem with no discernable sector outperforming another.)
We have now seen the 19th consecutive week of equity fund outflows with the last inflow not seen since back in May. This means that everyone is heading for the hills, or perhaps more appropriately the US treasury markets. Talk to your average financial advisor and ask him for a safe investment and he will probably tell you to buy bonds and notes. Traditionally speaking, he is right, but we are at a crossroads where the decisions we make today may have enourmous implications for all of us down the road. In buying a US 2 yr note, you are agreeing to lock up your money for a rate of return. Right now, the prime concern is deflation or the increase of value in money, which actually makes buying notes and bills ( or a CD) and attractive idea. Think of it this way, if the value of your money increases, not only will you benefit from the increase in purchasing power, but also the interest paid on your investment. Yet interest rates are virtually at all time lows. By buying a 2yr note, you are agreeing to lock up your money at one of the lowest rates of return in history. Though it may seem like a good idea now, will it still be a good idea in 1 year? What if you bought a 10yr note? Would you still be ok in 5 years? These are the questions you have to ask yourself.
Better yet, let’s look at things from the other side. Now instead of lending money, or buying a tbill/note/bond, you are borrowing money to say…buy a house. Interest rates are low now so it’s time to buy right? Well of course we need to delve deaper. Why are interest rate low? In the wake of the first downswing in the stock market, the FED has lowered overnight lending rate to near zero. This means credit is easier to come by. But for whom? The banks. The FED only controls the overnight lending rate. All other rates are more or less and extension of this level. So now the banks can borrow from the FED at low rates and are supposed to be turning around and lending back to the consumers so they can go out and buy a house, car, xbox, iPad…whatever. We are a debt driven consumer economy. If this was actually happening we would be out the so called recession and not heading in the worst part of the biggest depression the US has ever seen. What has been going on is that the banks are using the discount window to borrow from the FED and buy short term US treasury notes. In effect using tax payer money for risk free returns. Thanks guys! Where’s my cut? The velocity of money, or speed with which it circulates through the economy is dismal at the moment. Meaning that the bailout money given to the banks is taking a lot longer than expected to trickle down to the individual. Much like Reagan’s plan, this one is also a sham. Money is sitting in the banks not going anywhere and if you were a bank, would you do anything different? I know I wouldn’t.
What is also going on in the inerest rate markets makes this whole predicament very very interesting. Basically, fewer and fewer people are stepping up to buy US treasuries at these low rates. Just too much uncertainty to want to lock up your money for that long. But what appears to be happening is a shell game of debt. The FED is basically monetizing US debt. Or in simpler terms printing money to buy treasuries. If you don’t know the dynamics of the rate market maybe this little part will help clear things up. Interest rates are inversely correlated to treasury prices. Prices and rates are determined by how many people actually want to buy said treasury security. The more willing buyers, the lower the interest rates have to be for the US to keep selling debt. What has been going on behind the scenes is possibly the biggest ponzi scheme ever passed off in the world. I have this from trusted though unproved sources the FED has been printing money, using that money to buy all the toxic MBS crap off foreign central banks, with expleicit agreement that the banks then take the money and buy US treasuries with it. This seems to be a good idea for all. The US treasuries stay well bid keeping interest rates low, which by extention helps the housing market, and foreign central banks get to trade in their shitty Mortgage Backed Secuties (MBS) for higher quality US Treasuries. This is all well and good except for the Himilayan sized moutain of debt being incurred by the US. This debt will have to be paid off some time, but for now, it is causing massive fear for the value of the US dollar. Therein lies the rub.
Biflation
Fear is a powerful motivator, and in my opinion, the fear over the US’ increasing debt load will cause a move from deflation to hyperinflation within the next decade. Right now, we see some signs of Biflation. Home prices have been falling, while it seems to cost more to buy a loaf of bread has increased or at least stayed the same. It all stems from demand for goods. Right now there isn’t a whole lot of demand for homes, but the demand our demand for food hasn’t changed. Is the recession/depression continues, these problems will only multiply. Continued low demand for home prices will feul lower home values which will eat away at lines of credit which means less money to spend on day to day activities. Less spending leads to lower company profits which leads to more layoff/higher unemployment which leads to higher defaults on home loans which leads to higher interest rates which lead to a less active housing market which leads to lower home prices. And the cycle starts anew! Such the deflationary spiral we are in. Lower home prices will prompt the FED, with their ingenious Keynsian economic ideals, to continue to print money to prop up the treasury market to keep rates low to stabalize houseing market. This will incur more debt which will lead to further fear of the value of the US dollar. When this fear over the US Dollar turns to scorn, we will shift to hyperinflation. You will not be able to sell your dollars fast enough. No one will want them and neither will the US. Hyperinflation comes from a total collapse in confidence of the paper money sysetm. Even though all the other central banks around the world are doing virtually the same thing, no one does it quite as big and as bad as the US. We’re fucking America for Christ’s sake. No one can beat us at our own game.
The Race to the Bottom
It sure seems that the world is in a race to devalue its respective currencies. The lower the value of your currency, the less debt you need to pay off. Think of it this way, if you borrow $100 at 3% interest, but the value of that money falls by 2% in that year (2%inflation). The value of your $100 is now $98 because of inflation but you owe 3% on that $100 or $3. Inflation helps the debtor out in this case as the net result is owing $1 on the $100 your borrowed. This is a very simplified view of inflation and in fact you still owe $3 on the loan, just that the value of the $100 you borrowed is now $98. This is the place the that US is in now. With trillions in debt held by the US, how will we pay it off? Higher taxes? That would probably kill any semblance of a recovery let alone cause even more bypartisan bickering on capitol hill. Lower future interest rates? Wrong again as the FED has taken the rate market about as low as it can go. The option currently being used is the brush it under the rug for the next generation to deal with strategy. Buy issuing every increasing amounts of debt, the US is able to pay off its current liabilities in exchange for larger future liablities. This only make sense if we expect to see rampant inflation down the road.
True, the US is left liitle choice in this matter now, but it should be clear that the US does not have the US Dollar’s best interest in mind. The problem I see this time around is that we will not see the type of inflation that lead to the housing run up in 07. Things are far too complicated this time around. What I suspect we will see is another furious collapse in home values coupled with an explosion in the cost of food, energy and other tangible goods. Such an event could trigger a restructuring of the entire financial system, and almost certainly would remove the the US Dollar as the reserve currency of the world. Without reserve currency status, there is little reason for world players to buy and hold dollars and those that still are will sell dollars in favor of other currencies or goods.
What makes this so complicated is the fact that all developed contries are essentially in the same quandary. The bank of Japan recently interevened in the Currency markets because their currency is far too strong. As Japan is an export nation a higher YEN reduces their competitive edge. In Europe we are currently wacthing the next shoe dropping for Greece’s debt problems. Now it seem Portugal will be next in line to take IMF funds. One could argue that Greece and Portugal are small parts of the EU, but one needs to understand that if one country defaults on its debt obligations, it will seriously impair other countries from paying off theirs. Things are far too intertwined these days for problems to be isolated to individual countries let along individual companies.
As the developed countries start the currency debasement race, we are left wondering what end result will be. Who will have the last laugh? In the end, I think the end result will be a debasement of all currencies as all central banks ramp up the fiat priniting presses. When the world wakes up to vast amount of money now losing purchasing power it will cause a flight inflation tracking markets. Gold and Silver are making impressively higher highs while the agricultural markets are going parabolic.
One of the most interesting phenoma we have seen as of late is the recent divergence between Gold and Treasury prices. The Treasury market has recently begun a minor slide lower, indicating higher a lack of desire for locking money up in US. Gold and Silver on the hand have starting running substantially higher as have safety currencies like the Aussie and Canadian dollar. Investors are fleeing the dollar right now. Whether or not this continues unabated is yet to be seen, but it is rare to see this kind of divergence which has such dire implications. In future posts I will try to cover this in more detail.
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