Minyan Mailbag: Weak Dollar AND Deflation?
We are all trying to figure out where we are.
At Minyans in Manhattan, paraphrased, you've said: 'When participants want to take on more risk in the various markets, they take out additional loans and buy assets with the money. When they want to assume less risk, they sell assets and buy Treasury Bills. That is the real driver of asset prices.'"
I think your comment provides a good explanation of why risk markets struggle when the Fed is cutting rates. It also infers that the Fed does not "control" rates, but actually follows the treasury market; John Hussman makes this argument too.
If I further extend the relationships you describe, the inverted yield curve results from an excess of risky asset chasing. The party should be in its last thralls right now, as it was when the yield curve inverted in 2000.
OK, if you're still reading this, here is where I don't meld with your deflation scenario. In order to stop this party, the last bottles of booze - sake and Jagermeister (JPY/CHF) carry trades - need to be slugged down with chaser of Wrigley's Spearmint Gum. I don't see those bottles getting polished off until the crack, errrr, the dollar crack arrives. As the dollar dives, inflation usually rises.
So, my question: can we have a weak dollar AND deflation?
Mad Minyan Brad
I have an inflation/deflation scenario. I am wrestling with "can central banks induce a round of hyper-inflation or has it already passed?" My conclusion, however, is the same: every hyper-inflationary period (rising nominal asset prices) eventually is followed by a deflationary bust (the last bottle of booze). We are all trying to figure out where we are. But make no mistake: the weight of all that debt created by central banks will at some point be too much to bear.
All this credit has created a series of "bubbles" in asset prices. The Fed is disingenuous when they say they don't try to prevent them, but manage the aftermath. They actually consciously create them as a means to continue speculation and debt growth. The last was supposedly the real estate bubble because it is the largest asset market. But it turns out that the last one might not need one large asset class to "get liquidity into consumers' pockets." It may not even be based on generating consumption.
Perhaps the last bubble involves all asset classes and is being accomplished through monetization. The Fed creates credit and then borrowers take that credit and buy Asian goods. They need an asset class, like real estate, as collateral for that borrowing. Then they spend any excess liquidity driven by higher asset prices and spend it.
Those created dollars are being sterilized by foreign central banks accomplished by their creating more credit and then buying U.S. securities. Perhaps we are now seeing that last bubble: foreign central banks buying all kinds of private assets like corporate bonds, mortgages, and yes even stocks with that credit.
So the last bubble morphs from a consumption bubble to a speculation bubble.
This does not seem to bother some as it does me. What happens when governments buy private assets and crowds out private investment? You get excessive risk taking of course; everyone goes into debt even more.
I paraphrase Mr. Steve Galbraith when he said "investors have reacted rationally to free money (negative real interest rates). They borrow it. Debt is good when rates are negative." I still wrestle with this comment. It sounds right, but in the end I do not think it is. It sounds right when you look only at return. Of course it is rational to take money at a negative interest rate and lend it back out at a positive one. I have described the yen carry trade as this, but there are ever increasing risks associated with it. In order to get that free money there is currency risk: long dollars and short yen. There is no free lunch. So when investors take that "free money" they risk default when rates return to normal. So when risk is factored in, the risk of losing all, taking free money may not be so rational.
And so when governments buy risky assets they in a way force private investors to take risks that are not rational. LBOs are done that make little economic sense and redistribute wealth by destroying it in the future. Hedge funds are given so much liquidity they speculate.
The bottom line is as credit expands, nominal asset prices rise. But as credit expands because it is created and not generated by normal economic activity, the debt reaches a point where it can no longer be supported. Central banks are just finding more creative and dangerous ways to cajole markets into taking more credit.
I do not know when this point will be reached (deflation). There are signs now of excessive speculation, but I saw that a while ago too. But it is cumulative so we know from deduction that we are getting closer and closer. When deflation does kick in the dollar will rally, yes. But that may be from much lower levels.
The only thing we can be sure of is the degree to which this situation has risen. The imbalances are immense.
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