Deflation: On a Comeback? The welling@weeden Interview...
Excerpted from NFTRH137, this segment sort of spontaneously combusted as I was updating the technical and fundamental status for the precious metals sector. The welling@weeden interview with Mark Lapolla, discussing familiar arguments for deflation, showed up in my inbox several times last week and also appeared at Zero Hedge. Thus, I have to assume it made its way in no small degree into the public investor psyche - and right on cue I might add. ;-)
The gold miner bullish stance depends upon periodic destruction of inflationists' confidence. It depends upon the reserve currency not breaking down catastrophically but rather, catching the short covering bid. In this environment, gold will out perform nearly everything except for a time, the USD as it receives the knee jerk benefit of a speculating herd caught off side and seeking safety. A then very young NFTRH featured a Time Magazine cover during Q4, 2008, a time during which Robert Prechter led a whole host of d Boys back to the promised land as these very intelligent and well thought out people again went into full lecture mode:
Deflationists are finally emerging as evidenced by the well-traveled welling@weeden report (an interview with Mark Lapolla of Knight Capital) that seems to be everywhere on the internet of late, including multiple times to my inbox as well as here at Zero Hedge: http://bit.ly/kvoitR. At the least, it appears that the collective investor psyche is ready to accept deflation once again.
Perfect, because this chart twittler has been searching for a sign that the 'continuum' was not going to break and the long term US Treasury bond would retain confidence and a bid other than that of the Federal Reserve or foreign creditors operating a global labor arbitrage Ponzi racket. Enter welling@weedon.
Yet, it is not enough to simply be a contrary wise guy for the sake of being contrary. We must entertain the idea that deflationists could be right this time or find valid reasons why they are not. Otherwise, we are moving forward on unchecked assumptions.
So to put it simply, the NFTRH gold mining stance depends on the d Boys being right (again) for a time. It depends on government and the Federal Reserve doing what they have done most intensely since the macro backdrop changed in secular fashion in and around 2000; meeting any deflation threat with massive and undeniable inflationary policy. This ultimately leaves true deflation believers holding cash and wondering why they are not only not buying assets for pennies on the dollar, but watching said assets rocket higher in response to all the newly created money that transforms into speculative demand for said assets.
I admit that I have still not had the time to closely read the w@w report, and that may be a good thing so as I will not be influenced by it as I write what I believe, not what someone else believes. But in skimming, I have noted some familiar themes.
The report talks about how the Fed can create all the money it wants, but this money cannot make it to Main Street due to the impairment of real estate, and "no collateral" by the washed out public. It promotes the familiar theme that the credit binge cannot possibly continue to expand and debt must be unwound, as the system is at the end of an epic cycle of what I will call 'something for nothing'.
There is nothing wrong with this analysis because, in my opinion, it is reality. The interview goes on to talk of China vs. Silicon valley and as the overly intellectual deflationists usually do, complicates things too much in my opinion. I swear that the d Boys can be victims of the their own superior intellect because damned, they are right; Prechter was a big influence on me a decade ago. He made sense in everything I read of him, including the need for the massive credit construct to melt down and the inability of the Federal Reserve to prevent said meltdown.
The newsletter is called Notes From the Rabbit Hole because I have read the book, seen the movie and lived the reality for so long, knowing how right the case for deflation is, and yet it never seems to become actualized.
The Fed cannot save Main Street, but that does not stop the Wizard from trying. The problem is that newly created money does not go to Main Street - and if I want to think really negatively, I wonder if it was ever intended to - but rather, it enriches the first abusers and privileged classes. It also helps out you and me, if we are sharp enough to preserve capital when appropriate and then deploy capital (being brave when others have gone fetal).
I think a lot of deflationist theory - and ill conceived inflationist theory for that matter - depends on the idea that prices, jobs, wages, etc. have anything to do with anything. Inflation is promoted and actualized, regardless of jobs, wages or what have you. The money is going somewhere, but after its creation, I can assure you that it is not saying "hey, here I am newly minted funny munny; I think I will denominate myself in the hands of the bust-out public so they can buy high some 'cheap' real estate - or better yet, pay off legacy mortgage debt." No, this money goes where the action is first and foremost. It goes to the precious metals, led by gold as fear is at a maximum, and later, as some shreds of confidence return, silver and on outward to the greater commodity, resources and emerging market sphere. In other words, the play is on and a new cycle kicks in, money seeks out value and productivity.
Back to the w@w interview... Mr. Lapolla talks a lot about the consumer, about jobs and about the need to restructure and save. Credit cannot expand forever, no matter the Fed's wishes. The old system is failing. Sound familiar? It is core to this newsletter. But this does not stop inflation and, it can be argued, is a major enabler of future inflation initiatives, as long as the public remains bamboozled and retains its core confidence in policy makers, which it does. We will know confidence, wheither real or ginned up by T bond market manipulation - is lost when the upper line breaks:
Mr. Lapolla goes into many familiar deflation rationalizations, showing how well intellectuals tend to follow the bread crumbs conveniently laid out for them. They do not miss a thing, except the reality of how the cycles ultimately have played out up to this point. Here I will repeat something written often in the past... deflation is trying to happen continually during the great and ongoing inflation, and periodically it bubbles up to the surface and becomes a major concern as it would 'correct' the malfeasance promoted through modern monetary policy.
So I guess ultimately I am a d Boy, because I believe deflation is the right and good corrective needed to end what I consider a somewhat vile system that is geared to enrich the rich beyond what is deserved, if not beyond their wildest dreams, and impoverish the struggling and the poor (ie. non-investor classes), even as they generally have little clue why they continually fall behind (it must be the evil oil cartels and/or 'speculators' cranking up gas prices, illegal immigrants taking jobs and respective core beliefs of 'the liberals' and the 'the conservatives' doing the damage. These are of course in play, but it seems that the man behind the curtain, running the Money Show is the source of discontent through unequal distribution, not a would-be savior of Main Street.
"Increased money supply is not a causal factor for inflation. It's like suggesting that a bartender is a causal factor for alcoholism. In reality, reserves, whether they exist in the system's books or not, are always available. Credit creation cannot really be controlled. If you and I want to create a loan between ourselves, we can do it. If a bank wants to create a loan, it can do it. The only thing that can mitigate that ability is regulation of the banks. However, if we consider the off-balance-sheet and shadow banking mechanisms, there really is no way to control that credit creation. The only way the Federal Reserve can influence credit creation is by raising or lowering short-term rates. With that said, we're at the outer bound, at zero, and what we're finding is that demand for money is not increasing as the cost of money goes to zero -- which is not unlike what we saw in Japan. What is happening, however, as ever when the cost of money stays this low, is that speculators are inclined to speculate because the cost of speculation on leverage is negligible."
I do not find much of anything above that I disagree with, aside from the first sentence, which then throws everything that comes after it out of whack. Of course credit creation cannot be controlled. If it could, it might be controlled into areas that benefit the economy and its ability to sustainably grow and prosper. But that is a different fairy tale. We are in Wonderland.
"The reason [we don't have systemic inflation] is that the labor markets are fractured. So, at the end of the day, what we're having now is an asset inflation again, an echo. We're not seeing the seeds or leading edge of wage/price inflation, the true driver of damaging systemic inflation. Asset inflation resolves itself in one way, and one way only, and that's through asset deflation. So we have ongoing asset deflation in the residential real estate market. We have ongoing asset deflation in the commercial real estate market and we will ultimately have asset deflation across China and Asia."
Here, the deflationist reveals the point at which the argument fails. The analysis is based on the lagging prices that so many people think of as inflation. Hell, the FOMC in its own official releases refers to inflation being under control because wages and prices generally are. Well, wages certainly are, and so too I suppose are prices after enough massaging has been done to the numbers and the goods measured.
Get this, wages are not and never were slated to rise in this cycle. Jobs? Who the hell cares? This is about getting money out there to the effect of ever diminishing returns in the areas that do not offer value propositions like the debt saturated consumer (and by extension, the jobs market). This speaks to the core point of why inflationary policy is destructive; money is created but cannot be controlled in its destination.
So analysis that talks about monetary policy not working because 'money' is not getting out there to the jobs market and thus driving up wages and inflation, is way off the mark. Inflation is getting out there alright, just look at gold's firm and steady bull market. Commodities, while subject to periodic declines and even crashes as deflationary events kick up, thus far have risen strongly in response to each inflation cycle (again, defined here as increased money supply by policy).
But if analysis is going to focus on 'asset deflation' then okay, we will have a bout of asset deflation, but a better term would be 'asset price destruction' because that is what would be in play. As long as the continuum remains intact, actual inflation (policy) will remain in play, to the upside bias of asset prices again one day.