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Macro Random Thoughts

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In the late stages of a hyperinflationary credit expansion, ALL assets correlate.

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  • Hyperinflation (monetary and price) has always led to deflation in every fiat currency-based economy. Global central banks have hyperinflated over the last 3, 10, and 20 years, resulting in (primarily) asset and commodity hyperinflation rather than wage inflation (thanks to Chinese labor arbitrage). The US economy, along with the rest of the world, is about to enter the 'bust' phase of the classic boom-bust process that easy credit policies engender. With the rapid, and in some places violent, declines in housing prices, commodity prices, and stock prices (particularly emerging markets) since the beginning of 2006, the probabilities are high that a significant bust and an outright recession take place in 2007.

  • Despite the Fed's attempts to inject liquidity into the system (~9% y/y M3 growth), consumers and corporations are apparently reaching their ceiling for debt appetite. Real liquidity - Money AMS - is declining rapidly, suggesting that appetite for credit is slowing rapidly. This indicates that Global central banks will be pushing on a string should they ease short rates anytime soon. The liquidity cake appears to be baked; a credit contraction is most likely underway and, in a debt-laden economy like that of the US, such a credit contraction could feed on itself and become a cascade of defaults, bankruptcies, and write-downs.

  • In the late stages of a hyperinflationary credit expansion, ALL assets correlate. Oil, gold, silver, stocks, emerging markets, junk bonds, real estate: they have all risen substantially (some hyperbolically - a sure sign of speculative excess) over the last 4-5 years. If indeed the approach of a deflation credit contraction is nigh, the opposite forces will be similarly (and as relentlessly) at play: all of those assets will likely go down. Stocks, real estate, emerging markets, junk bonds, commodities (including silver and gold as well as industrials): each is likely to suffer multi-year bear markets as the speculative excess gets punished by declining liquidity and risk aversion.

  • In a deflationary credit contraction, the USD is likely to be bid as risk seeking abates and time preferences decrease. Though the long term secular forces in play are resoundingly negative for the USD, a credit contraction is likely to lead to significant (intermediate term) strength in the USD before those long term forces manifest in a serious decline in the value of the USD.

  • Markets are non-linear and as a result, traditional risk calculations fail to adequately measure the real risk of an asset. Further, volatility tends to cluster; a big down or up day tends to increase the probabilities of another big down or up day thereafter, which is proof again that markets are non-linear (and manifestly not rational). Lastly, human beings use their limbic systems to herd in the absence of full knowledge: when investors do not know, they are impelled to act as if others do. This herding leads to power-law fingerprints in the price-time series for assets; fingerprints that can give investors a probabilistic edge in determining likely future paths for negotiated financial markets.
No positions in stocks mentioned.

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