Minyan Mailbag - Crossing the Rubicon
I am glad my original post has stirred up so much debate. I appreciate the responses from other Minyans on this critical issue. The answer to this puzzle is a very critical one.
The answer determines whether or not one should invest in bonds for the upcoming deflationary ice crunch or short bonds for the upcoming inflationary fire.
In actuality I agree with previous responders to my post. Ultimately there will be hell to pay for this inflationary credit expansion. The key here is ULTIMATELY.
Yes we are dependent on Asia (Japan and China) to support our currency. But.... That is the trend and the trend is your friend. What will it take for this trend to stop?
That is the immediate question at hand. IMO the trend will stop IF and ONLY IF there is some other external demand outside the USA that breaks the chain of this world imbalance as USA the consumer of last resort and China the producer of everything.
Minyans, please take a look at housing, jobs, and wages. The signs are clear as a bell... The U.S. consumers are about ready to throw in the towel. I fully realize this has been stated before but now we see definite indications from USA housing inventory, leading economic indicators, and USA falling lumber prices.
Check this lumber chart out.:
Someone tell me that chart is inflationary!
With all the capacity in China, if the U.S. consumer gives up and/or if U.S. housing stalls, someone please tell me who is going to pick up the slack for all of the output coming out of China. Japan has proven 100% without a doubt that expansionist monetary policy can NOT defeat a K-Winter cycle. IMO it was the sign of hubris from Greenspan to announce the defeat of deflation just as everyone wrote off the possibility. The big "inflation bust" scenario is very very real BUT only if wages are rising and demand is rising. There quite simply is NO worldwide demand outside the U.S. If we stop buying their stuff they will stop buying ours. Period. End of story. Trade worldwide will slow.
As for the issue of currency, is the Yen or the Euro better than the US$? If so why? Europe and Japan have a far bigger demographic problem than the U.S.. In addition, their balance of trade is better than ours because we are buying tons of their stuff. What happens when U.S. consumers FINALLY hit the wall? No one yet has been able to tell me where Japan and China and Europe sell their goods to. Who wins in a worldwide recession? Are there winners?
Ultimately there is one simple truth.
Whatever China demands is inflationary. Whatever China produces is deflationary.
But... At some point if U.S. demand falls, and there is no demand to replace it. The chain breaks. Are we at that point?
I think we have crossed the Rubicon. The bond market is reflecting that right now IMO. In fact there is every chance that U.S. interest rates have been fully normalized. Right here right now at 1.75%. Reckless expansion of credit by FNM and FRE is responsible for a large part of these inflationary pressures we have seen. More houses means more furniture, more carpets, more lumber, more grass seed, more appliances, more everything. The cessation or even the stalling of these needs is quite deflationary.
To assume that this debt will be inflated away is totally foolish IMO. Essentially it is an admission that this reckless expansion of credit was justified. It is an admission that Greenspan was able to defeat K-Winter and brag about it. It is an admission that people get what they want as opposed to what they deserve. Well I am not willing to admit any of those things. A housing slump in the U.S. will without a doubt cause a worldwide recession. That event will hardly be inflationary regardless of what oil prices do.
Here is a fact I just learned today:
The American Consumer represents 70% of U.S. GDP, and in turn the U.S. represents about one third of world GDP.
The U.S. consumer represents (0.33 x 0.70) = 23% of world GDP, while only representing roughly 5% of the world's population.
How long can this last?
What happens to the world economy when it stalls?
If we stop buying their stuff at the current rate how can they afford all of the current capacity they have?
With rising gas prices, rising heating oil prices, rising medical expenses, and with housing outstripping affordability even at 1.75% interest rates, someone tell me who blinks first: the U.S. consumer or Japan supporting the US$.
Yes, Minyans inflation will indeed come. But that is down the road. It will be preceded by an enormous housing slump, a big stock market collapse, and a destruction of all of this ridiculous expansion of credit. That is what is deserved. It is not what anyone wants. Timing is everything. We are seeing FALSE inflation just as Japan did in one of numerous economic maladjustments they used in a foolish attempt to defeat K-Winter. We have followed in their exact footsteps.
For a good as well as current read on the inflation/deflation debate I recommend this article:
Here is the June 06 Eurodollar chart (U.S. interest rates).
Tell me that is not bullish looking. (chart going up = expected interest rates headed down).
Check out interest rate futures in the UK.
Totally flat as a pancake.
Going out all the way to Sept 2009 interest rates are expected to stay in a .25 range!
This is an amazing opportunity for any kind of volatility play.
With housing stalling in the UK for me it is a one way bet.
Disclosure: It is obvious where I stand.
I am long interest rate futures in the U.S., the UK, and the EU.
I believe that interest rates are headed lower or at the very least interest rates in the U.S. will rise slower than what has been priced in.
After the deflationary bust (and who knows how long it will be prolonged)... then and only then will the inflationists be right.
Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at email@example.com.
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