Inflation on Demand and Along the 'Continuum'

By: Gary Tanashian | Fri, Oct 14, 2011
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Global markets are in the midst of a predictable relief rally to the technical bear market that recently became actualized off of various topping patterns that were in force for most of 2011. It is important to note that this is coming off of a similarly predictable whiff of a deflation scare, as US and European debt 'imbalances' (a polite way to put it) spooked the public out of asset markets and into US Treasury bonds, among other 'safe' havens.

Ben Bernanke, the current US Fed Chief, is a deflation scholar after all. He is the man for the job and if he was hesitant to do his job, as was the case last spring amid the 'austerity movement' and a red-lined long term T bond yield, he can be less so now. The 'bad cops' (Fisher, Plosser, Bullard, etc.) at the Fed have been marginalized for the time being with people like Robert Reich and Paul Krugman, along with their decidedly less financially austere views, are back in the public consciousness.

This is what happens during what NFTRH calls the 'continuum', which is the secular trend in T bond yields. For decades now, one could simply navigate the alternative pinging of the upper boundary (100 month exponential moving average; inflation fears brewing at red arrows) and the lower boundary (green dotted line for a routine deflation issue and sold green line for a whopper of a deflation event) and manage risk as needed.

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But risk management has very different meanings at the each of the opposite poles. At the top of the continuum, risk must be managed against a failure of the inflation tout as commodities and ultimately most asset markets top out. At the red arrow, the herd has bought the play and gone all in. The result? Predictably, as long as the continuum remains intact, the result is a lot of pain for a lot of trend followers. Hello future deflation scare.

But do we really believe that an actual enduring deflation can come about? Part of my personal risk management at the most recent (inflationary) red arrow was to be aware of the lower probability that the continuum could break upward (above the EMA 100). Currently, I also respect the deflation case until such time as enough indicators trip and policy is enacted that shift the odds to a scenario that sees the same herd that got stuck in commodities at the most recent top get stuck in Treasury bonds at their highs. A hint in this regard is the gold-silver ratio, which is currently NFTRH's most critical tool for measuring market liquidity and lack thereof.

But there is no need to force things. I hold my core of gold stocks which, for reasons tracked each week in the newsletter, are the right asset class for the counter-cycle. I also hold a relatively large percentage of cash due to the message of the continuum and with respect to the deflation argument. If however, the more probable scenario holds, with the continuum remaining intact - and this does not prove to be the 'final deflation' - the system will wheeze, grind and churn forward ultimately toward the next intense bout of inflationary hysterics. Cash would most definitely be 'trash' once again.

As the continuum grinds along, gold grinds higher. Much to the dismay of many deflationists, I might add. What the 'dBoys' fail to account for in my opinion, is the 'lever' that a deflation impulse represents. In other words, it is the lever that a certain policy maker may pull in order to promote more inflation along the continuum. Gold is one of the very few assets not to be fooled by this macro economic Kabuki dance. Gold is a monetary barometer after all. That is its main job within the Keynesian system of credit and paper creation; to reflect the pressure on the paper monetary system.

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But you, astute monetary student, know all about gold and its inherent value proposition in a world with very little else in the way of strict monetary insurance. So let's move on.

People who look at prices and scream INFLATION! are behind the curve. The inflation is cooked up in the money supply, not as a result of rising prices. Rising prices is the symptom; the long term and ongoing symptom in many cases. Let's look at the big picture of several important 'symptoms' of the ongoing inflation that has been promoted over the cycles, up down, inflationary, deflationary, decade after decade...

CPI: Food

You want to feed your family? Well, that is an endeavor of value and despite the implied threat of deflation, things of value rise in a system of paper money creation out of non-productive means. Incidentally, does this 'hockey stick' look similar to the golden one in the chart above? I realize the time frames are different, but the age of inflation onDemand (i.e. when the Fed no longer saw fit to even hold the pretense that it was an inflation fighter - thank you Mr. Greenspan) began right about the time that gold's hockey stick began to form its blade, in and around the secular changes of 2001.

CPI: Tuition

You want to educate your kids you say? Well, get in line and prepare to figure out a way to keep up with inflation.

CPI: Medical Care

Healthcare... yes that is a very important one as well.

CPI: Housing

Another essential, housing, has taken a break in its relentless drive upward in prices. This is due to the levels of credit creation employed to game this market into 2005 (again, compliments of Greenspan). Credit is unwinding and housing is decelerating post-2008 recession. I am not qualified to speak about how official policy aimed at avoiding a housing implosion may be affecting the graph. But housing is, at least temporarily, a candidate to 'deflate' further, absent additional 'bailout' policy aimed directly at mortgages.

M2 Money Stock

Now for the stuff that gets the inflationists really excited, the money supply. M2 is doing as it has done well, forever. It is rising impulsively. I have seen credible analysis stating that this is due to a repatriation of USD to US shores in the wake of the Euro crisis. So don't get too excited just yet. The point is driven home by M2's velocity, or lack thereof, which gets the dBoys all worked up.

velockty of M2 Money Stock

Rut Roh... with this kind of structure and long term deceleration of 'free money', one wonders about how hard policy makers are pushing on that string as M2 velocity has declined for a decade now.

MZM Money Stock

MZM hockey stick...

Velocity of MZM

MZM velocity is a stick in the mud.

Institutional Money Funds

Institutional money, which is likely smarter than you or me, has not been buying the US 'recovery' since 2008. Along with the money velocity data, this argues that the deflation case should be respected even as we look forward to the promotion of a coming inflation cycle. It is the promotion of this cycle that we will be interested in, not necessarily its perceived success.

We are either nearing the next great contrarian opportunity along the continuum in the age of Inflation onDemand, or the end of the system as we know it. In other words, what I affectionately call 'Prechter Time'.

Place your bets ladies and gentlemen, but do so with all due risk management as applies to the very different conditions represented by the two opposite poles along the continuum. There is inflation and there is deflation, but as yet, the all clear is not signaled toward the inflation case, in which a new 'asset grab' would ensue toward markets and resources of value.

I do not have the ultimate answers, but I can guarantee you that I work as hard as possible to illustrate the current conditions and status within the ongoing inflation/deflation struggle at any given time to keep my newsletter on the right side of the markets. I invite you to give Notes From the Rabbit Hole a try on a monthly basis (for subscription flexibility) or a discounted annual basis. You can also go to the blog ( and pick up a free sample copy of NFTRH156, dated 10/9/11, to review further.



Gary Tanashian

Author: Gary Tanashian

Gary Tanashian

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