Steve Keen talks about debt

open this talk by referring to the first presentation at the conference (after Julia Gillard’s opening speech) by Professor Joshua Gans, in which he began by describing both Milton Friedman and Hyman Minsky as “Keynesians”. Had one of the students in my History of Economic Thought subject at UWS made such an observation, he/she would have been well on the way to a fail grade. I was hoping that SlowTV might have also posted Joshua’s talk so that you could make your own minds up on this, but that doesn’t seem to have occurred. Those curious about his approach to economics should check this link to his home page and a blog he established called Core Economics.

http://www.debtdeflation.com/blogs/2009/11/06/my-per-capita-talk-on-debt/

Interview with Harry Dent

Using exciting new research developed from years of hands-on business experience, Harry S. Dent, Jr. offers a refreshingly positive and understandable view of the economic future. As a best selling author on economics, Mr. Dent is the developer of The Dent Method - an economic forecasting approach based on changes in demographic trends.

In all of his past books since 1989, Dent saw an end to the Baby Boom spending cycle around the end of this decade.

In his new book, The Great Depression Ahead, (Free Press, 2009), Harry Dent outlines how this next great downturn is likely to unfold in three stages, with an interim boom stage between 2012 and 2017 before the long-term slowdown finally turns into the next global boom in the early 2020s. In his book The Great Boom Ahead, published in 1992, Mr. Dent stood virtually alone in accurately forecasting the unanticipated “Boom” of the 1990s. Today he continues to educate audiences about his predictions for the next and possibly last great bull market, from late 2005 into early to mid 2010. Since 1992 he has authored two consecutive best sellers The Roaring 2000s and The Roaring 2000s Investor (Simon and Schuster). In his latest book, The Next Great Bubble Boom, he offers a comprehensive forecast for the next two decades and explains how fundamental trends suggest strong growth ahead, followed by a longer-term economic contraction. Mr. Dent also publishes the HS Dent Forecast newsletter, which offers current analysis of economic, and financial market trends.

Mr. Dent received his MBA from Harvard Business School, where he was a Baker Scholar and was elected to the Century Club for leadership excellence. Since 1988 he has been speaking to executives, financial advisors and investors around the world. He has appeared on “Good Morning America”, PBS, CNBC, CNN/FN, and has been featured in Barron’s, Investor’s Business Daily, Entrepreneur, Fortune, Success, US News and World Report, Business Week, The Wall Street Journal, American Demographics and Omni.

While at Bain & Company he worked as a consultant with several Fortune 100 companies. He has also been CEO of several entrepreneurial growth companies and an investor in new ventures. A frequent speaker on economic trends, Mr. Dent educates clients and partners on The Dent Method and provides strategic vision for asset allocation and investment selection.

Audio

Debt deflation debacle ~ Dr Lacy Hunt, of Hoisington Investment Management

Steve Keen has support here...

Isabelle Oderberg: How did we get ourselves into debt deflation?

LH: Well it's been a long time in the making. The debt to GDP ratio took out the highs of the 1930s and 2003. At that point in time total debt was just a little bit more than $3 of debt for every dollar of GDP. Today it is just under $3.60 of debt for every dollar of GDP and we are going to see that ratio move higher, in part because normal GDP in the United States is now falling and the difficulty of repaying this debt is going to be very difficult, because the loans are denominated in dollars and the assets that were borrowed against are dropping in value. The income generating capacity of these assets are also dropping and the US economy is in something called a debt deflation. A very rare situation. It only occurs every 3 to 8 or 9 decades. The last time that we experienced it was the 1930s in the United States. We experienced it in the 1870s and 1880s and Japan experienced a debt deflation post 1988 but it has happened historically. It is very rare and the two main things that identify it are setting a new peak in the debt to GDP ratio and also a lot of borrowing that is improperly financed and where there is little likelihood that the borrower can repay the principal and the interest of the loan.

IO: What scenario are we going to see now?

LH: These debt deflationary periods tend to last. They're very pernicious, they're very persistent and they tend to last a long time. Really, the only thing that brought the United States out of the post 1929 debt deflation was our participation in World War II. The debt deflation that ensued after the panic of 1873 lasted another 20 to 23 years and the Japanese, they had debt deflation which started 1989 and is still running for all practical purposes today. They last for a very long time.

IO: According to your quarterly review and outlook, we're now essentially in a 15-year process. Does that mean that it's going to take 15 to 20 years for this situation to actually stabilise or normalise?

LH: Well, there are other intervening events that could occur. If we would have very significant technological breakthroughs that might shorten the process, but one of the things that suggest it's long running is you can look at what happened to interest rates and stock prices after these prior debt manias. Post-1928 you had a negative risk premium for 20 years. Negative risk premium meaning the total return on treasury bonds exceeded the total return on the S&P 500. Post-1872 you had another 20 year period of a negative risk premium and we've seen a negative risk premium post-1988 in Japan. The low in interest rates after those previous debt bubbles occurred about 14 or 15 years later, for example the low post 1928 occurred in 1941 on the yearly average basis at 1.95 per cent. Once we went into World War II, then there were some very minuscule increases 20 years after 1928 interest rates were up slightly, but not very much from the lows that were reached in 1941 and that was also a characteristic of the Japanese situation and our situation in the US post 1872.

IO: So if we're in any way mirroring the '31 to '33 situation, is the S&P at risk currently of a bear market rally?

LH: Well, one of the things that has happened in these debt deflations is you get a number of false dawns. People believe that the normal business cycle is going to take control and you're going to get a cyclical recovery and the model that soon prevails is that you get three to 10 years of expansion. You have one year, maybe a year and a half of a recession or nasty economic conditions, but after a year and a half at most, the economy then has another expansion for 3 to 10 years.

When we have these very rare debt bubbles occurring at these long irregular intervals, the normal business cycle model doesn't really apply. We do get some false dawns. Some intermittent cyclical recoveries but the unwinding of the debt process proves to be very very long and difficult. One of the reasons for that is that borrowers don't know anything about paying back loans in harder times, which is what's now beginning to occur and as a consequence there is a major behavioural shift or there has been historically in which consumers decide to live inside of their means as opposed to living outside of their means and normally the saving rate goes up for a long time.

After the experience of the 1930s the savings rate in the United States rose irregularly into the early 1980s and it's been in a decline since then irregularly to extremely low levels, virtually the same low levels that we reached in the 1930s and if history is a guide and there are not many data points we're now beginning to see an upturn in the saving rates that will last for a very long time.

IO: You said that this could be a 15 to 20 year process unless there are technological breakthroughs. I was just wondering if you could give me some examples of breakthroughs that might occur and whether you're referring to any form of government intervention that might help ease the situation.

LH: Well, I don't believe that government intervention, particularly of the type that we're taking. is going to be helpful. In fact the government intervention may be hurting the situation.

IO: Are you referring to stimulus packages in their current form...

LH: A stimulus package in its current form? I don't even think the word 'stimulus' should be used. It's a grab bag of various political promises. The most recent academic research that I have seen, published in 2008, indicates that the multiplier on government expenditure is just close to zero. If the government spends an additional dollar it has to fund that dollar either by raising taxes on the private sector or borrowing funds in the capital markets that would have gone to the private sector. Government spending, the government sector in the US, the productivity is at best zero and perhaps slightly negative, so when we enlarge the government sector and shrink the private sector we reduce the growth, potentiality, of the US economy. We shrink the pie and we make things worse off.

The very extensive efforts that government spending by the Roosevelt administration in the 1930s really produced no meaningfully positive results. In April of 1939 as the rest of the world was going to war our unemployment rate was still above 20 per cent. The Japanese ran deficits of 10, 12, 14 per cent of GDP. They've had nothing more than a few interim cyclical recoveries in the past 20 years. We had a very long difficult process after we unwound the extreme amount of debt that was taken, that was built up during the railroad bubble of the 1860s and 1870s. Government spending in this matter in fact may make the situation worse.

Let me just give you another point here. Last year the treasury borrowed about $170 odd billion to mail out rebate cheques and a few other short-term stimulus packages. Conclusive economic research indicates that people did not really spend transitory income to any significant degree. And they did not in this case. In fact, they even spent less of these rebates than they did the Bush rebates of 2001. So we borrowed the money and deprived the private sector of the capital. The recessionary momentum rolled along and now we have another $170 odd billion of debt on our books which we're paying interest for. There is one thing that would help on the government side, but I doubt that politically it can be done. Christine Rohmer, who is the incoming chair of the Council of Economic Advisors, in her academic work has found that every one dollar reduction in the marginal tax rates will raise GDP by $3 after three years. The problem is that that takes time, because in the interim you have to still borrow the money. The treasury does not have the funds in its checking account, but we're not going the route of either reductions in the personal or the corporate tax rate and so we're actually engaging in spending activities that have a zero multiplier and are very unlikely to change the economic dynamic going forward.

IO: So essentially there's nothing that the government can do in this situation to assist?

LH: Well, I think that one of the things that might have helped would have been an alternative approach to the so called TARP [Troubled Asset Relief Program] bail out bill. There are two ways that we could have gone here, but there was no hearings held. It was just decided that that was the only way that we could go and so the treasury borrowed funds, used its borrowing capacity to try to prop up the entities.

The alternative, which the Japanese would have done and the better way to go, is to use the treasury borrowing capacity to protect the depositors and the customers of the banks and the insurance companies and perhaps extend unemployment benefits for their employees that are laid off. Zombie-like institutions intact with wholesale federal dollars, borrowed federal dollars – those institutions are really not able to grow or contribute to the economy. If instead we had protected the savers and the depositors, then institutions would have failed, but the healthy banks and insurance companies would have taken over the business of the institutions that made the mistakes and then we would have a growth trajectory going forward. So it's quite possible that the actions that we've taken and cost hundred of billions dollars, hundreds of billions of dollars have actually not helped the situation and may have had severe unintended negative consequences.

IO: You mentioned that there were no hearings for the TARP and I'm sure if we had a government spokesman on the call he or she would say 'well, we had to act quickly, we couldn't afford to hold a series of hearings and whatever', but I don't quite understand how they managed to get it quite so wrong if they had so many people telling them not to do this – very few people I've spoken to support the TARP.

LH: Well the public is hurting. The politicians feel the pain of the public sector. They want to be seen as responding to the pain and there is an overwhelming feel that they have to do something to help the public so we rushed through the rebate bill last year, the recessionary momentum moved on. It had no effect but that begs the whole issue of whether you should do something and if so if you do something is it the right measure or is it the wrong measure or does it have unintended negative consequences and I believe that we're taking the wrong steps.

Take for example one of the big things in the so called 'stimulus bill' is to increase spending for roads, highways and bridges. Last year we sent about $75 billion on such matters out of an economy of $14.5 trillion. An infinitesimally small component. If we were to double the component, the $75 billion spending it would still be an infinitesimally small component, but we couldn't double it overnight because you need architectural studies, engineering studies, you have to get environmental approval, you have to buy right of way, you have to satisfy community groups and in final analysis, road building is not a labour intensive function, it’s a capital intensive process. The folks that have been laid off in management and insurance and real estate and our young college graduates, they don't want to go and work alongside the road and there's not many of those jobs anywhere.

This is not the 1920s or 30s or even the 50s where there were thousands an thousands of people working alongside the road building the interstate highway system. This is a capital intensive process. It's not going to provide the jobs that are basically needed for the economy so here in this particular case we do get better roads and bridges which we need and which is a good thing in its own right, but it is not a stimulus package. In the case of construction of the green power plants, last year we spent less than $10 billion. If you double that which you couldn't do quickly it's still an infinitesimal part of the economy and it's also a capital intensive type activity and it would not provide jobs that people need.

IO: What specific things do you think the US government should be doing to try to create jobs?

LH: Well, you have to do things that change behaviour and the only thing that I know that changes behaviour is to reduce the marginal tax rates for individuals and also for corporations. Even this would not work quickly because of the deficit financing problem over the near term, but if you have a permanent reduction in the tax rates you raise the after tax rates of return and over time you will get definite multiplier benefits. As I mentioned earlier, the incoming chair of the Council of Economic Advisors has found that ever $1 reduction in the marginal tax rates will increase the GDP of total spending by $3. That's a multiplier of 3 to 1. In the case of government spending, the multiplier is zero. There's no net benefit for going along the expenditure route. So in the haste to do something and to show the public that they care about their plight, the politicians are doing something but in fact they're doing the wrong thing.

IO: Do you think with the shift in the way that unemployment figures are measured in the US, do you think that the situation is worse than it appears with unemployment?

LH: I think that there is a lot of unemployment. There's not just the standard headline unemployment rate, but we have the unemployment rate that takes into consideration people that are looking and can only find part time work, far less than the want, including people that have quit looking over the last year . But going back a number of years back to the Clinton Administration we used to have a U7 unemployment rate that took into account people that had quit looking because they couldn't find work in the last five years. I think if you were to use that old, expanded, non-official definition of unemployment you might find that it's probably as high as 17 or 18 per cent. The U6 rate which is published by the Bureau of Labor Statistics is currently showing about an unemployment rate of about 13.6 per cent, double the official or headline number.

IO: Specifically on lending and borrowing, you said there is a pattern of consumers are starting to move towards saving more and living perhaps within their means. In your note you say lending and borrowing is pretty much suspended. No one's lending, no one's borrowing. Is there anything the government, Geithner or anyone else can do to try and invigorate that situation? Interest rates are about as low as they can go.

LH: The great American economist Irving Fisher who did the pioneering work in debt deflation. Milton Friedman the Nobel Laureate called Irving Fisher the greatest' economist that America ever produced'. One of the Fisher's great competitors during his lifetime was Joseph Schumpeter [an Austrian economist] who taught at Harvard. Fisher was at Yale. Schumpeter said Fisher was the brightest man that he ever met.

Fisher, who did the seminal work in debt deflation, lays out the case that once you have in a period of extreme over indebtedness and a price disturbance began, the price level or the value of the assets falls and the income generating capacity of the assets falls, that it controls all or nearly all other economic variables. That's a contrary view to what Milton Friedman said. Friedman contended that if the Fed had prevented the decline in the money supply during the Great Depression the velocity of money which is outside the Feds control would have stabilised. So would have nominal GDP and the Depression would have [been avoided]. Fisher takes a different view.

Once we've got the extreme over indebtedness, really there's nothing that we can do and one of the problems is that the velocity of money is likely to fall very sharply and although the Fed has managed to increase the money supply, velocity has dropped even more sharply and that's why nominal GDP is falling so at least in the early stages of this difference of opinion between Friedman and Fisher, Fisher appears to be correct.

IO: There's no intervention that the Fed or anyone else could do to stop that process from evolving?

LH: Well I think the Fed is doing all that it can. If you read Ben Bernanke's essays on the Great Depression it's clear that he believes that the Friedman view is correct and he is pulling out all the stops to try to contain these deflationary forces but there is a credible expert in the field that made the point that it was quite possibly at the situation that nothing meaningfully can be done other than time to correct the problem. I know no one wants to hear that but that in fact may be the situation.

IO: In terms of S&P going forward, there could be a series of false starts or bear rallies, but is that how you see the market unfolding? Can you give a little insight into your outlook for the market going forward?

LH: I don't have a short-term view but I think if you look at the 20 years, post-1929 in the US, 1928 in the US, 1988 in Japan and post-1872 in the US, for those 20-year periods, you had a situation where the total return on treasury bonds, which was in the single digits leading into low single digits, exceeded the total return on equities and the total return, not only the income or the dividend, plus or minus whatever the change was in the capital value. And I think that we may be facing a situation similar to that as this process unfolds and although it cannot be said definitively, I think that there is a risk that the diversified portfolio model may not work in debt deflations.

Debt deflations, although they're very rare, if you study them you will see that they turned the world upside down as we know it. And another difficulty with these debt deflations is that no one that's alive today has in their own personal data bank, their personal history of experiences the prior experiences because they didn't live through them. It occurred before they were born. If they were alive during those time periods they were very small children. They may have learnt something either from parents or grandparents or so forth but it is very difficult for people of experience and practicality to understand what is gripping the situation when they have not ever lived it and that's one of the great difficulties for the US today and I suspect for the world as well.

IO: There have been some downgrades to the sovereign debt of some nations and some are predicting there will be more, especially the European countries that have very large current account deficits. Do you think that there will be likely further downgrades to sovereign debt and whether we will start to see defaults?

IO: Well I think that one of the difficulties for the entire world is that it's been very dependent upon sales of goods and sending their production to the US consumer. The main determinants of consumer spending in the US are income and wealth. We have experienced a wealth loss of approximately $11 trillion in the household sector through the end of last year. We don't know the final numbers but it's in that vicinity. The Federal Reserve's econometric model indicates that every $1 wealth loss will lower consumer spending 7.5 cents over three years.

Using that formula, the drain on consumer spending from the wealth loss alone is about 3.4 per cent per annum this year and 3.4 per cent per annum in 2010 and 3.4 per cent in 2011. And that's a larger drag than the average rise in consumer spending of about 2.9 per cent over the past two decades. The wealth loss will have a very material impact. The wealth loss is now being reinforced by an income loss. The income loss is stemming from massive lay offs and increases in unemployment and reductions in employment and those two forces are causing imports into the United States to fall.

As we buy less from the rest of the world it means there's less income and production overseas. One of the benefits is that the US trade deficit, which was 6 per cent of GDP has declined or improved to 3 per cent of GDP and as the further wealth and income effects depress discretionary spending it's quite possible that the US trade deficit may be eliminated in the next three or four years, which means that we'll continue spreading weakness to the rest of the world and it raises the risk of financial difficulties around the globe.

http://www.businessspectator.com.au/bs.nsf/Article/Lacy-Hunt-$pd20090129-NR997?OpenDocument

Hyperinflation or deflation?

At present, the investment community is divided as to whether the world economy faces hyperinflation or deflation. Some observers are convinced that the central banks’ printing press will take the world towards hyperinflation whereas others believe that the ongoing contraction in American private-sector debt will result in outright deflation. So, what will the future bring?

It is my contention that we will get neither hyperinflation nor deflation.

What is more likely is that over the coming months, we will get another deflationary scare. Any sell-off in the markets later this year will be met by an even larger stimulus from the policymakers and this will ultimately result in high inflation.

So, I maintain my view that due to the unprecedented policy responses around the globe, the world’s economy will face high inflation over the medium to long-term. And the general price level will double over the coming decade.

In the near-term however, we will probably get another period when the market will (once again) become concerned about the prospects of a lengthy economic contraction. It is conceivable that the ‘green shoots’ hype currently doing the rounds will soon be replaced by more economic worries as a second wave of foreclosures hits America later this year. So, it is possible that before year-end, we will witness large corrections in stocks and commodities. Conversely, we are likely to see big rallies in US government bonds, US Dollar and Japanese Yen.

This near-term vulnerability in the markets is the reason why I have recently liquidated our ‘long’ positions in resources and emerging markets and gained a heavy exposure to long dated US Treasuries. In my view, a defensive investment stance is prudent at this juncture as it will protect our capital and allow us to profit from the expected contraction. Once the pullback in the markets is complete, I will liquidate our positions in US Treasuries and re-invest our capital in our preferred holdings in energy, materials, mining and emerging Asia.

Look. In the business of investing, the tape never lies and it is worth remembering that Wall Street is littered with the graves of those who got married to one particular outcome and then held on to their ill-conceived notions. At this point, when private-sector debt contraction in America is locking horns with central bank inflation, I prefer to have an open mind. Therefore, I am maintaining a defensive near-term investment position. If the market corrects over the following weeks, I will be in a position to profit from such a decline. On the other hand, if the major indices simply consolidate here and break above the recovery highs recorded last month, then I will have no hesitation in changing my defensive investment position. Put simply, I am currently watching and waiting patiently for the market to reveal its hand.

Coming back to the subject of this essay; the reason why I don’t foresee immediate hyperinflation is due to the fact that the velocity of money is currently weak. In other words, at least for the moment, the private-sector in America isn’t participating in Mr. Bernanke’s inflation agenda. Despite the fact that Mr. Bernanke has injected a massive amount of reserves in the banking sector, this money is currently sitting as excess reserves within the American banking system. The fact that this money isn’t being lent out rules out immediate hyperinflation. However, once the American economy stabilises and the velocity of money picks up, these excess reserves will trigger a massive inflationary wave.

As far as deflation is concerned, I am of the view that the policy responses and our fiat-money system will ensure that the purchasing power of cash will continue to diminish over the medium to long-term. In fact, I am willing to bet that cash will probably be the worst performing ‘asset’ over the coming decade. Remember, in today’s monetary system, central banks and governments the world over are free to create money out of thin air and this will prevent outright deflation in the global economy.

It is worth noting that in the past six months alone, China’s commercial bank credit has expanded by a whopping US$1 trillion! Figure 1 highlights the surge in Chinese bank lending. Furthermore, credit is also expanding frantically in other Asian nations. So, contrary to the West, monetary policy is still alive and well in the developing nations and this factor also rules out outright deflation in the global economy.

Figure 1: Explosion in China’s bank credit



Source: Bank of China

In my opinion, rather than hyperinflation or outright deflation, we will witness elevated inflation after the American economy has stabilised. In the interim however, investors should be prepared for another deflationary scare and the associated market panic.

Puru Saxena

Saxena Archives
email: puru@purusaxena.com
website: www.purusaxena.com

Willie ~Watch the primary US bond dealers ~ Dresdner Kleinwort exit

My rebuttal reflects what China clearly manifests as a strategy. The rest of the large creditor nations are certain to either follow the Chinese path or set out on a parallel course. Past work has called the Chinese initiatives the spearhead against the USDollar. They realize they must smother (but not kill) the USDollar slowly, eventually suffocating it only at a time their many initiatives are fully deployed in place, much like a neck noose built into a straightjacket. The strategy has two important sides. First, they are protecting their outsized core of US$-based bonds of several stripes. They choose not to embark on any aggressive strategy that would seriously undermine their core holdings in reserves. However, they are not stupid. They see the unprecedented and colossal debauchery of the USDollar via trillion$ in new debt, with seemingly little or no concern over foreign reserve holdings, demands, or priorities. The USGovt believes it can deflate its debts one more time, delivering foreigners weak coffee at the lunch counter, and get away with it. They cannot time, not this time, especially since the USEconomy is stuck in a deteriorating spiral, the US banks are insolvent (despite phony accounting), US households are insolvent, and US industry is either absent or depleted. Foreigners are far too aware of the USGovt attempts to inflate debt away, actually an impossible task as those debts multiply like bacteria, or better described as CANCER. The US leaders want to reduce both the value of the debt burden and assure that its ongoing service costs are kept low. Foreigners are in revolt, threatening to pull the plug.

So foreigners have embarked on a broad response. Second, they are diversifying away from the US$ at the margin in bold moves. They are devoting NEW trade surplus funds to hard assets, like stockpiles, like grand production contracts, like large acquisitions and partnerships. They are regularly urging wider acceptance of the I.M.F. bonds as an alternative to storing surplus funds outside the US$ sphere. In fact, the Chinese lead the global initiative to end international contract settlement in US$ terms, after several decades. They do so with yuan currency swap facilities scattered across the globe like so many automatic teller machines. They do so with historically unprecedented bilateral barter accords, whose systems are being assembled and put into place. See Russia with China. See Russia with Germany also. The stockpile movement is not strictly a Chinese phenomenon. The Shanghai Coop Organization (SCO) recently completed a global meeting, with several key invited guest nations like Brazil. Their unstated purpose was to make concrete steps in contract settlements for a variety of commodities (from crude oil to natural gas to industrial metals), and do so without USDollar involvement. The June SCO meeting in Yekaterinburg Russia was hardly covered by the US financial press. Where it was covered, it was downplayed. Also, despite its many problems within the European Union, like economic recession and wounded banks, foreigners are flocking to the Euro currency, now over 141 and pushing toward 142.

NO, the major theme of 2009 on the Psychology Billboard is REVOLT AGAINST THE USDOLLAR AT THE MARGIN, NOT THE CORE. The foreign creditors and suppliers to the Untied States are in a coordinated global revolt position, being fortified with each passing month. That is the major theme of 2009. Notice the shutdown in Chinese purchase of USTreasury Bonds, down to a mere trickle since October. In fact, the objective of those in revolt is to play down their revolt, to talk nice to the USGovt (which controls an aggressive military), to utter empty words about support for the USDollar, but to work behind the scenes to undermine it AT THE MARGIN. Their exercise is akin to soothing and singing to a large wounded beast, as it is being surrounded, tied up, and muzzled. Their objective includes a pace of undermine intended to be gradual.



Foreign creditors wish to use their USTBond reserves in constructive intelligent manner. The Chinese recently announced a dedication to hedge funds from their vast sovereign wealth fund holdings, a likely avenue for USTBonds used as collateral in accounts. If properly deployed, with sufficient volume, additional USGovt debt can be used to fortify the commodity prices and prevent a perverse unjustified USDollar rebound, built upon failure and liquidation. Slowly but surely, the credit supply for the USGovt and USEconomy will be reduced to the point that later, unclear how much later, it will be cut off.

FOREIGN VULNERABILITY

Reading economic reports from foreign lands serves as a distraction to this entire ill-footed deflation versus inflation debate. Some like my outspoken acquaintance believe that foreign economic distress assures continued decline in US asset prices. They miss the main point. Foreign economic distress assures less trade surplus recycle into USTreasury Bonds, and further isolates the USDept Treasury into monetizing their debt. A DEEP ISOLATION COMES TO THE UNTIED STATES AS FOREIGN CREDITORS BOTH REFUSE TO FUND AND CANNOT FUND THE PROFOUND CRIPPLING US DEBT. Hidden within the bowels of the funding process is the gradual destruction in the official bond primary dealers. Last week, Dresdner Kleinwort decided to exit in its role as a primary bond dealer. The US-based dealers are sitting on a mountain of inventory, acting like a huge collection of boulders on a medium sized vessel at sea. Primary dealers now have a record $368 billion in Corporate, Agency (mortgage), mainstream mortgage bonds, and USTreasury inventory. And the vast bulk of their holdings of USAgency debt has less than a 3-year maturity. Just like the private equity groups and Wall Street firms, they are heading toward a day when they choke on their own feces.

The USEconomy is most vulnerable to price inflation, due to US$ weakness and revolt globally against it, as commodity prices are inversely linked. The USEconomy is perversely the most protected from price deflation. The deflationist argument might possibly hold some water with foreign economies, as their currencies rise enough to harm export trade, as their strong currencies keep commodity costs down. The Deflationist Knuckleheads at best have it backwards, and at worst continue to be lost.

http://www.financialsense.com/fsu/editorials/willie/2009/0701.html

Inflation Will Be A Surprise

Earlier this week, the Labor Department reported declines in both the Producer Price Index (PPI) and the Consumer Price Index (CPI). Various economists and television commentators believe that these declines are proof that slack in the economy is creating deflation and more than offsetting the inflationary impacts of government stimulus spending and money-printing by the Federal Reserve.

A deeper look at the CPI report shows a different picture:


Source: Department of Labor

The far right-hand column shows that the "All items" CPI headline data declined 0.4% over the past twelve months. This figure is what the deflationists are citing as evidence of deflation. However, the "All items less food and energy" figure rose 1.8%. The whopping 23% decline in energy led to the overall decline in prices or "deflation" that economists cite. It is worth nothing that it took a 23% drop in energy prices to create a 0.4% decline in CPI when energy prices are still so high compared to the last couple of decades.

Prices in the broader economy are not falling despite the worst recession since the 1930's because of the government's programs and the mind-boggling increase in the Federal Reserve's balance sheet. Velocity of money (spending and business transactions) has slowed due to the weakness in the economy. However, as reflected in the chart below, holdings of cash are exploding. As people in the deflation camp alter their deflationary forecasts, holders of cash will rightfully become nervous about their loss of purchasing power. As a result, the velocity of money will rise despite the weak economy - a theme quite common for highly indebted countries. To believe that there is deflation today and to assume it will continue into the future is to misunderstand the definition of inflation.





Market dislocations occur at major turning points when markets falsely forecast the path of inflation versus deflation. For example, in 1982 the market was incorrectly fearful of inflation, which meant stock and bond prices were quite low and provided for outstanding gains if the inflation fear was unfounded. As is now known, inflation had ended and thus it was a great time to buy stocks and bonds.

Today, the market is counting on deflation. As a result, gold is undervalued and US stocks and bonds are overvalued because the market believes deflation will persist until only mild inflation replaces it. As Peter Schiff says, "A little inflation is like being a little pregnant." Stock P/E's contract and interest rates rise during high inflation. As reflected in the chart above there is a huge amount of cash on the sidelines. When fear of deflation subsides and the harsh reality of inflation sets in, cash will flow to commodities and hard assets and thus lead to higher consumer prices rather than higher stock prices (until we have hyperinflation, which clearly is not on the market's mind).

In summary, stocks are rallying and investors believe in deflation. As of March 2009, the CPI is helping to inflate the deflation story. However, at some point, markets will either begin to discount that CPI will turn higher or there will be a rude awakening when the data is released. Either way, inflation will be a surprise because the markets are incorrectly discounting the future.

http://www.safehaven.com/article-13111.htm

Wage Deflation Sets In ~ Mish

Wage deflation is setting in. Let's look at some anecdotal evidence.

The Times Plans Temporary Pay Cuts
March 26, 2009

Facing a steep drop in revenue, The New York Times Company plans to cut the pay of most employees by 5 percent for nine months, in return for 10 days’ leave, and will lay off 100 people and make other budget cuts, executives said on Thursday.

The company will make the pay cuts unilaterally for most nonunion employees, including top executives, in its corporate division, at the flagship Times newspaper and at The Boston Globe. The reductions will be in effect from April through December.

At The Times newspaper, the company will ask the Guild, which represents most newsroom employees, to accept the 5 percent cut and 10 days off voluntarily, and avoid possible layoffs. It is not clear how the moves will affect unionized employees at The Globe.
McClatchy to cut 1,600 jobs, lower salaries
March 9, 2009

Struggling newspaper publisher McClatchy, parent company of Charlotte's Observer, said Monday that it would cut 1,600 jobs and lower salaries across the company.

McClatchy (MNI), based in Sacramento, Calif., said the job cuts amount to about 15 percent of its work force. The company plans to begin laying off workers and restructuring operations by the end of the first quarter. The reductions will result from a combination of layoffs, attrition and outsourcing, the company said.

McClatchy said that its salary reductions would include a 15 percent cut in Pruitt’s base salary. In addition, other executive salaries will be hit with a 10 percent reduction, while board members will see a 13 percent decline in cash compensation, including retainers and meeting fees. Also, McClatchy will pay no bonuses to executive officers this year.
Gannett puts 15% pay cut on the table
March 12, 2009

The Indianapolis News Guild is sad to inform you that Gannett is now seeking to cut the pay of newsroom and building services employees by 15 percent. The lawyer for the company provided us with a one-page “supplemental” proposal this afternoon that he said would implement this uniform salary reduction either 1) at the time we reach a new contract with the company, or 2) at the time both sides reach an impasse and cease talks.

This was a disappointing move, given that we thought the company’s bargaining team was starting to embrace the concept of negotiating instead of dictating. In fact, we believe the company’s actions at the table today raise the specter of regressive and bad-faith bargaining.
Microsoft temps face 10 percent pay cut
February 26, 2009

The thousands of contractors who work at Microsoft through third-party agencies are facing pay cuts beginning Monday, as Microsoft continues to look for ways to cut costs.

Microsoft and its contracting agencies agreed to a 10 percent cut in the bill rate, impacting all temporary worker assignments. Several contract employees have said the reduction is being passed on to them in the form of a pay cut. One person said some agencies are seeking to pass deeper pay cuts onto their workers. Several contractors contacted The Seattle Times, asking for anonymity for fear that speaking out would jeopardize their jobs.

The 10 percent cut is for existing contracts. New contracts will have a 15 percent reduction in the rate.
The Oregonian Newspaper Takes Cost Cutting Measures
March 23, 2009

The Rocky Mountain Paper closed recently after 150 years in print. The Seattle Post Intelligencer can only be found on-line now. And Portland’s Willamette Week has instituted an 8 percent pay cut.

So the staff at The Oregonian knew cuts were coming.

Nobody from the Oregonian's management responded to a request for an interview. But in a letter to employees Publisher Fred Stickel said that the Oregonian lost “several million dollars” last year -- and doesn’t have enough income to cover expenses this year. Stickel says quote:

"The economic crisis has dramatically worsened the precarious financial situation facing the media industry, our Company, and many of our advertising customers."

To fix the problem he announced a 15 percent pay cut for himself and other top staff, and a five or 10 percent cut for other employees. Some part-time workers are also being laid-off, while other staff will be required to take four furlough days over the next few months.
'Spokesman-Review' to Freeze Wages, Seek Salary Cut
February 18, 2009

SPOKANE, Wash. The Spokesman-Review newspaper will freeze wages in 2009, and seek a 5 percent salary cut for all managers, non-union employees who earn more than $11 an hour, and, with their voluntary consent, all union employees.
Morris Communications to reduce worker wages
Wednesday, March 18, 2009

Morris Communications Co. announced today it will reduce employee wages by 5 to 10 percent effective April 1. The reductions will affect hourly and salaried employees.

Mr. Morris said the pay cuts are designed to preserve jobs in a difficult economic environment.

"The newspaper business is facing unprecedented challenges," Mr. Morris said in a news release. "Just yesterday, after 126 continuous years of publishing, the Seattle Post-Intelligencer printed its last edition. Other newspapers have sought protection from creditors in bankruptcy court, severely cut back on their publishing schedules or abandoned the business entirely.
ADN announces staff, pay cuts
March 19th, 2009

The Daily News will cut its work force and reduce wages as part of a major nationwide effort by its owner, the McClatchy Co., to cut $110 million in expenses to offset declining advertising revenue, Patrick Doyle, the newspaper's publisher, told employees in a letter Thursday.

This will be the third round of staff reductions at the newspaper in 10 months and is symptomatic of an industry-wide crisis threatening to sink newspapers across the country.

Staffing at the Daily News will drop by 45 people, or about 17 percent, through a combination of buyouts, layoffs and the elimination of vacant positions, Doyle said. Seven of the jobs eliminated were the result of new, more efficient production equipment.

The cuts will affect every department, from circulation to advertising, production and news.

The paper will also impose pay cuts ranging from 2.5 percent for lower-paid employees to 10 percent for the highest paid, Doyle said. Those making less than $25,000 a year will not see a reduction.
Koreans Take Pay Cuts to Stop Layoffs
March 3, 2009

Shinchang Electrics Co. offered union leaders a proposal that would reduce wages at the auto-parts company by 20% in exchange for no layoffs among its 810 workers this year. Eight days later, the union agreed.

The deal is one sign of the unusual way South Korea is grappling with the global economic crisis. Across the country, executives, salaried employees and hourly workers at companies from banks to shipbuilders are joining to slash wages and other costs with the goal of avoiding layoffs.
Singapore Press Reduces Pay, Halts Hiring Amid Slump
March 12 (Bloomberg) -- Singapore Press Holdings Ltd., the city-state’s largest newspaper publisher, will cut wages and bonuses of 3,000 employees and freeze hiring to reduce costs amid the island’s deepest recession.

The lower salaries will result in a 20 percent drop in the overall wage bill, the company said today in a statement to the Singapore exchange, without giving a figure for savings. Hiring has been halted and profit-related bonuses will drop, it said.

Singapore’s government has said the economy may contract as much as 10 percent this year, prompting companies to fire staff, cut pay and conserve cash. Singapore Airlines Ltd. has offered more than 14,000 workers the option of as much as two years of unpaid leave, the Straits Times reported on March 11.

“We need to bring our costs down in the face of a weaker advertising market and uncertain business environment,” SPH Chief Executive Officer Alan Chan said in the statement, which was released after the close of trade. “It is imperative that we prepare for a longer-than-expected downturn.”
HP to cut staff wages by 5% as print revenue drops
23 February 2009
HP has said it is to slash most of its employees' wages by 5% in a bid to combat declining revenues and reportedly save around 20,000 positions worldwide.

The cuts come as revenue within HP's Imaging and Printing Group dropped 19% to $6.0bn (£4.19bn) in the first quarter to 31 January 2009.

Supplies revenue in the group was down 7%, and commercial hardware revenue and consumer hardware revenue dropped 34% and 37%, respectively.

The manufacturer recorded a 33% dip in printer unit shipments and commercial printer hardware units were down 39%. Operating profit for the group was $1.1bn – equivalent to 18.5% of revenue.
Con-Way to cut employees' base wages by 5%
March 9, 2009

Con-way Inc. (CNW) said late Monday that it will cut base wages and salaries of executives and employees of Con-way Freight and Con-way Inc. by 5% and suspend certain 401(k) contributions in an effort to further reduce costs. The trucking company will also reduce the salaries of Chief Executive Douglas Stotlar and certain members of the senior leadership team by 10%. The measures, which are scheduled to be completed early in the second quarter, are expected to save the company between $100 million to $130 million in 2009. Con-Way had already cut 2,500 positions, suspended bonuses and reduced capital expenditure during the fourth quarter.
Sacramento Bee Staffers Approve Pay Cuts
March 6, 2009

Newspaper Guild members at The Sacramento Bee agreed Friday to take pay cuts of up to 6 percent to save jobs at the 152-year-old paper.

Members voted 65 percent to 35 percent to accept the deal, said Ed Fletcher, a reporter who heads the Guild's local at the Bee.

Even with the pay cuts, Bee managers plan to cut 34 of the 268 Guild-covered positions in the editorial and advertising departments. Another 19 jobs would have been in jeopardy if the union had rejected the pay cuts.
IBM Cuts Jobs as It Seeks Stimulus Money
March 25, 2009

Reports of deep job cuts at International Business Machines (IBM) come at a potentially delicate time for the company—just as it is hoping to secure money from the federal stimulus package. The company will lay off as many as 5,000 U.S. workers in its Global Business Services unit, transferring some of the work they performed to India, according to media reports.

Any job transfers IBM may make to India would occur at a sensitive time, as the recession deepens and as the U.S. unemployment rate climbs. Moreover, the company would be cutting high-skill positions domestically as it and others jockey for new business from the $787 billion stimulus package Congress enacted in February—primarily to help create U.S. jobs.

Currently, 29% of IBM's workforce is in the U.S., down from 35% in 2006. The fact that IBM has built up large workforces in such low-cost countries as India allows it to shift work abroad more easily, says Ron Hira, assistant professor of public policy at the Rochester Institute of Technology. He says the current economic climate allows IBM to position itself as one of many firms squeezed by the recession and forced into layoffs. IBM "can now blame the layoffs on the economy, masking the reality that it is offshoring high-wage, high-tech jobs to low-cost countries," says Hira.

But while offshoring has been on the rise for decades, the economics of the recession are creating a new political climate that makes such moves more controversial. That's because, as IBM and others continue global restructuring, they're working to secure pieces of the $787 billion stimulus measure enacted in February.

IBM is seeking a share of the $8 billion the U.S. plans to spend on high-speed rail and part of the $20 billion in the stimulus plan to digitize the U.S. health-care system. Palmisano was one of 13 executives who met with President Barack Obama in January in an appearance aimed at pressuring the House of Representatives to pass the economic stimulus bill. He joined the CEOs of Xerox (XRX), Motorola (MOT), and Google (GOOG).
Wage Deflation Tally

9 Publishers
IBM
Hewlett-Packard
Microsoft
Con-way Freight
Shinchang Electrics

Wage deflation is setting in like wildfire in the publishing industry. Technology and trucking are affected as well. Budget cuts in California and other states are affecting teachers. Rest assured this is not inflationary news.

http://globaleconomicanalysis.blogspot.com/2009/03/wage-deflation-sets-in.html

That's it. We're scroomed.

Rasputin - Wed, Mar 18, 2009 - 05:57 PM

Anyone who has followed my numerous, boring, repetitive posts through the years is painfully aware that I have spent inordinate amounts of time harping about Ben Bernanke's November 21st, 2002 speech entitled:

"Deflation: Making Sure it Doesn't Happen Here".

...the link to which can be found here:

http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm

In this lengthy speech, Bernanke essentially laid out the "Road to Weimar" regarding the steps the Fed could take to fight a major-league deflation/depression.

Many people derided my dissections of Bernanke's speech through the years as they just couldn't accept the fact that the Fed would resort to such drastic measures as Bernanke was threatening to do.

The nay-sayers stated that the Fed would NEVER buy Agencies, NEVER prop up private financial institutions, NEVER resort to outright monetization to fend off "Great Depression II"

Well, today the Fed officially "crossed the Rubicon" with their statement that not only are they going to massively bump up buying dead Agency MBS, but also dive into buying Treasuries as well.

And in no small amounts either.

So, Bernanke is finally making good on every single threat he made in that fateful speech made in 2002.

The Fed will literally burn the currency to the ground to impel the masses to start spending and borrowing again.

And please don't make the fatal mistake of believing that the Fed will now simply fold up its tent and walk away from this "to-the-death" fight between the forces of debt and derivatives destruction and the central bank's efforts to overcome it: There is no turning back now.

Furthermore, today's statement by the Fed makes it painfully clear that the Asian central banks are pulling back on their Treasury/Agency purchases and the Fed has to step up and monetize the MASSIVE amounts of new U.S. government debt that is being issued.

So, this is it. We're scroomed. The Fed just threw the panic switch and admitted they are now totally desperate. And remember, this action comes a FULL YEAR AFTER the Maiden Lane, LLC creation and trillions of fiatscos already flung at the debt and derivatives collapse. One would have thought that by now the central banks would have the situation well under control.

But they don't.

So, the bottom line is this:

The gloves are off. This is a fight to the finish.

And the Fed doesn't care if it totally destroys the U.S. fiatsco in order to re-ignite the "Animal Spirits" of rampant spending and speculation.

In fact, they are encouraging it.

Perfect Storm for a Balance of Payments Crisis?

As argued in “Road to Ruin: Final stretch” the US is vulnerable to a balance of payments crisis. The cause of that crisis is the convergence of four main crisis events, and we are ready to say that these may occur within the next three quarters:
Epiphany that tax receipts will be dramatically lower than current estimates and expectations, creating a fiscal deficit shock (Timing: Late April or early May?)
Epiphany that demands on the Federal budget are higher than currently expected due to extension of lender of last resort operations to finance current credit market challenges and the inclusion of new rescue operations, such as to support credit card and insurance companies, and a series of funding crises, such as public pensions, and state and local government budget shortfalls. (Timing: Ongoing)
Supply crash meets money supply boom, resulting in rising inflation. All across the supply chain, from raw to finished goods, supply is falling. Starting with raw materials, it is easy to forget that mining is a capital-intensive process, and without credit production has slowed dramatically. Without trade credit shipping and trade have slowed dramatically. In terms of finished goods, the retail trade industry is contracting quickly. Much as occurred starting in 1975, government efforts to reflate the economy by increasing the money supply ran head long into a collapse in goods supply. Looking at trends in goods supply and money supply, a rise in inflation starting with consumer prices may have already begun. (Timing: Q4 2009 or Q1 2010?)
Epiphany that China will as its economy contracts not be able to afford to continue to purchase US Treasury bonds despite the virtually guaranteed result, a collapse in US export demand and value of dollar denominated reserve assets. The situation will be similar to that which the US and UK found themselves in 1930, unable to continue to make payments that maintained capital inflows that the German economy depended on to finance its fiscal and current account imbalances: the German economy collapsed in a Sudden Stop event in 1931. The timing of this event is very difficult because it is political; at what point does the cost of buying Treasuries outweigh the cost of not buying them? (See Economic M.A.D.) Long before the now common warnings from China are acted on, we should see some early signs [See: Headed for a Sudden Stop). One of those signs will be investors hiding out in dollar inflation hedges like commodities and precious metals, and we take the coincidence of falling Treasury yields and rising gold prices as a sign that some investors are preparing for a Sudden Stop event. (Timing: Q3 or Q4 2009?)
The near convergence of these events means they may occur either in sequence or more or less at the same time. For example, if clear evidence of inflation arises soon, that will cause Treasury prices to fall, and in fact may be causing them to do so already. The most likely trigger is a Tax Receipt Epiphany that leads to a Fiscal Deficit Shock and sudden loss of confidence in US sovereign credit quality.

The result in the fabled “Poom” of iTulip’s 1999 Ka-Poom Theory, a theory of the final stage of the disinflation and reflation process of the asset price inflation cycles that began in the early 1980s, began to end in early 2008 with the onset of debt deflation.

Charts

The deflation-inflation two-step: Too complex for deflationsts to grasp?

By mistaking the short term for the long term, they are missing the trade of the century

by Eric Janszen

Over 100 books, papers, and original analysis went into developing and refining Ka-Poom Theory over the years, and model that explains how, following the collapse of the credit bubble, the US economy will experience a short (six month to one year) period of deflation that we call disinflation, such as we are experiencing today, followed by a major inflation induced by monetary and fiscal policy and the actions of US trade partners in response to that inflation.

It appears that the deflationista camp is incapable of comprehending a model, and the events that it forecasts, that lays out a two step process. For some reason they cannot grasp the fact governments will respond to disinflation with inflation, that the impact of those interventions is not instantaneous, and that markets historically are not very good at foreseeing the change in inflationary conditions in either direction.

Ka-Poom Theory in 1999, the original disinflation/reflation theory developed nearly ten years ago, does not merely forecast a period of deflation or disinflation that is inevitable after the massive credit bubble popped. A child could do that. We call it "Ka" as the first step in the two step process outlined by Ka-Poom Theory. The difficult part is forecasting what comes after the disinflation phase. Does the Fed sit back and do nothing while the debt deflation runs out of cotnrol? Does the Fed have a choice, or does it become impotent, overwhelmed by the rate of debt defaults and money destruction?

The deflationistas apparently think what comes after post-bubble deflation is more deflation, as occurred in the early 1930s in the US but nowhere else ever since. It has not occurred to the deflationists why no similar period of deflation has ever occurred since the 1930s, or when they do confront the question they explain that the debt is really, really, really big debt this time, bigger than the Fed. Or that differences between the kind of money that the Fed prints versus the kind of money that the endogenous credit markets create when money is loaned into being by businesses and consumers means the Fed cannot impact the latter.

As we explain that in The truth about deflation, the reason no deflation spiral has occurred in any nation since the one instance in the US in the 1930s is because since then no nation has chosen to remain on the gold standard through a debt deflation. Needless to say, the US is not on a gold standard today.

What governments do when confronted with a deflation spiral is take measures to increase the money supply to induce inflation. If they succeed and money aggregates are increased, over time inflation will follow.

Money first, inflation second

One of the better papers on this topic is No money, no inflation—the role of money in the economy by Mervyn King, Deputy Governor, Bank of England. It was presented to the Festschrift in honour of Professor Charles Goodhart held at the Bank of England on 15 November 2001.
Most people think economics is the study of money. But there is a paradox in the role of money in economic policy. It is this: that as price stability has become recognised as the central objective of central banks, the attention actually paid by central banks to money has declined.

It is no accident that during the ‘Great Inflation’ of the post-war period money, as a causal factor for inflation, was ignored by much of the economic establishment. In the late 1970s, the counter-revolution in economics—the idea that in the long run money affected the price level and not the level of output—returned money to centre stage in economic policy. As Milton Friedman put it, ‘inflation is always and everywhere a monetary phenomenon’. If inflation was a monetary phenomenon, then controlling the supply of money was the route to low inflation. Monetary aggregates became central to the conduct of monetary policy. But the passage to low inflation proved painful. Nor did the monetary aggregates respond kindly to the attempts by central banks to control them. As the governor of the Bank of Canada at the time, Gerald Bouey, remarked, ‘we didn’t abandon the monetary aggregates, they abandoned us’.

So, as central banks became more and more focused on achieving price stability, less and less attention was paid to movements in money. Indeed, the decline of interest in money appeared to go hand in hand with success in maintaining low and stable inflation. How do we explain the apparent contradiction that the acceptance of the idea that inflation is a monetary phenomenon has been accompanied by the lack of any reference to money in the conduct of monetary policy during its most successful period? That paradox is the subject of my talk.
This paper contributed three concepts to Ka-Poom Theory that deflationistas should think very carefully about. Read the paper and its conclusions are inescapable.

One, if "No money, no inflation" then if "Money, inflation." Two, money first, inflation second with long and unpredictable time lags. Three, the money markets always get it wrong; inflation expectations are sticky following periods of deflation and sticky following periods of inflation. The big money to be made in our fiat money era is in betting that the bond market is getting it wrong rather than assuming that a market that is forecasting future inflation or deflation is getting it right. When governments are inflating, the bond markets tend to be right short term, wrong long term.

That being the case, this may be the trade of the century because the bond markets are pricing corporates, treasury bonds, and TIPS as if it's 1931 and the US and the world was on the gold standard, or it's 1974 and recession is about to take inflation down for the count. Mike Shedlock does a good job of describing the phenomena here recently in Industrial Bond Yields Strongly Support Deflation Thesis. The error is mistaking short term for long term inflation pricing phenomena. The one step deflationists miss is the all important second step in the two-step Ka-Poom deflation/inflation process.

King demonstrates the long term correlation between money and inflation in the UK going back to 1885.

KaPoom Theory

Hayman advisors ~ we doomed, period!

According to HAYMEN advisors, the problem is not because banks don't trust each other - the problem is that THERE IS NO MONEY LEFT FOR THEM TO LEND TO EACH OTHER.

�We have argued for years now that there is not enough money at the bottom of the levered pyramid scheme the world has put together�

In the U.S. alone, with Lehman, AIG, Bear Stearns, Fannie, Freddie, WaMu, IndyMac, Countrywide, and the rest of the companies that have failed to date (any many more "on deck"), there are $8 TRILLLION of assets already in receivership, conservatorship, liquidation, or "parked" with a big brother.

Do you think the Government will be successful in purchasing illiquid assets off of the balance sheets of troubled companies? The odds (and the assets) are against them.

How long and deep will this recession be?

We are experiencing the global deflationary bust of all time. It will deflate the values of just about all assets. Anything and everything we own will decline precipitously in value. We are not perma-bears like some others, but we must be realistic about facing this terrible economic environment. Unlike many, we don't believe the problem is either isolated from the “real� economy, or limited to the U.S. or that the world will be rescued by the invincible Chinese economy.

The world economies have already hit the iceberg

As we all know, what we see on top of the water is only 10-20% of the mass of the full iceberg. In the grand scheme of it all, there is really nothing that can be done. Both the US and the world economy are headed for a financial winter the likes of which we have never seen before (unless you happen to have been alive in 1929).

- �the most frightening chart we have seen is one that compares total credit market debt to U.S. GDP. The average of this ratio over the last 100 years has been around 155%. This ratio peaked first heading into the Great Depression at 260% (after then falling back to 130%) but has now risen to an unprecedented 350%!�

We think we will see 10-12% unemployment, a 4-5% decline in GDP, and the equity markets could drop at least 70% from peak to trough.


THE WORLD HAS LOST HALF OF ITS EQUITY MARKET WEALTH ($29 TRILLION) since last October. The negative wealth effect will be DEVASTATING

In the U.S., we are only just beginning to see the strain of tighter credit on consumer spending. As corporate earnings decrease and workers are laid off, the cycle of delinquencies and defaults will get worse.

This deflationary bust will take MANY YEARS and MANY BANKRUPTCIES to play out

We are but one year into the mother of all credit crunches and two years into a housing decline. Don't be seduced by anyone telling you that “all will be fine� anytime soon.

�...the fundamental flaw in the governmental response is that it is trying to re-lever an already massively overleveraged system in a short-term attempt to halt an unavoidable cycle of asset price deflation. This policy prescription is like treating the withdrawal symptoms of our global credit addiction with another hit of heroin. Like any addict, one hit is never enough and the only question remains is how long it takes the global economy to ask for just one more…�

- To date, some $550 Billion has been written down by the world's financial institutions. In the United States alone, there is $10 TRILLION of "Prime" mortgage debt, $1.5 TRILLION of Alt-A mortgage debt, and $1.2 TRILLION of Subprime mortgage debt. Based on our assumptions, we believe we will see cumulative losses of AT LEAST 25% in Subprime, 20% in Alt-A, and 5% in Prime. Our expected default rates and severities imply that over $2.2 TRILLION of defaulted mortgage loans would result in AT LEAST $1.1 TRILLION of REAL LOSSES in mortgages IN THE U.S. ALONE.
Â
- There are $6 TRILLION of untapped bank lines of credit not included on U.S. bank balance sheets (with very little reserved for them). This represents more than 6x the total equity of the entire U.S. banking system. The banks simply DONT HAVE THE MONEY TO LEND. This decision signed the death warrants of the "independent" broker-dealer model.
  Â
- If we assume that CDS is evenly distributed (although Lehman just proved it isn't), and that we will see S&P's predicted 23% cumulative defaults on speculative grade nonfinancials by 2010, then we will see approximately $2.6 Trillion of CDS in default (we think this number is low). If we use a 60% recovery rate (Lehman's was only 8.625%), we could see at least ANOTHER $1 TRILLION of losses in CDS contracts alone. We would argue that CDS contracts are written on more dubious assets by nature. Â Â Â

�Fannie and Freddie spreads to US Treasury bonds have hit their highest levels EVER today. Now that they are nationalized and explicitly guaranteed, shouldn't they trade at the narrowest spread ever? The bottom line is that there is no money in the global system to buy this stuff. Globally, investors are tapped out, and the leverage in the system has to come down. We have no idea how this is supposed to happen in an “orderly� fashion.�

According to HAYMEN advisors, the problem is not because banks don't trust each other - the problem is that THERE IS NO MONEY LEFT FOR THEM TO LEND TO EACH OTHER.

�We have argued for years now that there is not enough money at the bottom of the levered pyramid scheme the world has put together�

In the U.S. alone, with Lehman, AIG, Bear Stearns, Fannie, Freddie, WaMu, IndyMac, Countrywide, and the rest of the companies that have failed to date (any many more "on deck"), there are $8 TRILLLION of assets already in receivership, conservatorship, liquidation, or "parked" with a big brother.

Do you think the Government will be successful in purchasing illiquid assets off of the balance sheets of troubled companies? The odds (and the assets) are against them.

How long and deep will this recession be?

We are experiencing the global deflationary bust of all time. It will deflate the values of just about all assets. Anything and everything we own will decline precipitously in value. We are not perma-bears like some others, but we must be realistic about facing this terrible economic environment. Unlike many, we don't believe the problem is either isolated from the “real� economy, or limited to the U.S. or that the world will be rescued by the invincible Chinese economy.

The world economies have already hit the iceberg

As we all know, what we see on top of the water is only 10-20% of the mass of the full iceberg. In the grand scheme of it all, there is really nothing that can be done. Both the US and the world economy are headed for a financial winter the likes of which we have never seen before (unless you happen to have been alive in 1929).

- �the most frightening chart we have seen is one that compares total credit market debt to U.S. GDP. The average of this ratio over the last 100 years has been around 155%. This ratio peaked first heading into the Great Depression at 260% (after then falling back to 130%) but has now risen to an unprecedented 350%!�

We think we will see 10-12% unemployment, a 4-5% decline in GDP, and the equity markets could drop at least 70% from peak to trough.


THE WORLD HAS LOST HALF OF ITS EQUITY MARKET WEALTH ($29 TRILLION) since last October. The negative wealth effect will be DEVASTATING

In the U.S., we are only just beginning to see the strain of tighter credit on consumer spending. As corporate earnings decrease and workers are laid off, the cycle of delinquencies and defaults will get worse.

This deflationary bust will take MANY YEARS and MANY BANKRUPTCIES to play out

We are but one year into the mother of all credit crunches and two years into a housing decline. Don't be seduced by anyone telling you that “all will be fine� anytime soon.

�...the fundamental flaw in the governmental response is that it is trying to re-lever an already massively overleveraged system in a short-term attempt to halt an unavoidable cycle of asset price deflation. This policy prescription is like treating the withdrawal symptoms of our global credit addiction with another hit of heroin. Like any addict, one hit is never enough and the only question remains is how long it takes the global economy to ask for just one more…�

- To date, some $550 Billion has been written down by the world's financial institutions. In the United States alone, there is $10 TRILLION of "Prime" mortgage debt, $1.5 TRILLION of Alt-A mortgage debt, and $1.2 TRILLION of Subprime mortgage debt. Based on our assumptions, we believe we will see cumulative losses of AT LEAST 25% in Subprime, 20% in Alt-A, and 5% in Prime. Our expected default rates and severities imply that over $2.2 TRILLION of defaulted mortgage loans would result in AT LEAST $1.1 TRILLION of REAL LOSSES in mortgages IN THE U.S. ALONE.
Â
- There are $6 TRILLION of untapped bank lines of credit not included on U.S. bank balance sheets (with very little reserved for them). This represents more than 6x the total equity of the entire U.S. banking system. The banks simply DONT HAVE THE MONEY TO LEND. This decision signed the death warrants of the "independent" broker-dealer model.
  Â
- If we assume that CDS is evenly distributed (although Lehman just proved it isn't), and that we will see S&P's predicted 23% cumulative defaults on speculative grade nonfinancials by 2010, then we will see approximately $2.6 Trillion of CDS in default (we think this number is low). If we use a 60% recovery rate (Lehman's was only 8.625%), we could see at least ANOTHER $1 TRILLION of losses in CDS contracts alone. We would argue that CDS contracts are written on more dubious assets by nature. Â Â Â

�Fannie and Freddie spreads to US Treasury bonds have hit their highest levels EVER today. Now that they are nationalized and explicitly guaranteed, shouldn't they trade at the narrowest spread ever? The bottom line is that there is no money in the global system to buy this stuff. Globally, investors are tapped out, and the leverage in the system has to come down. We have no idea how this is supposed to happen in an “orderly� fashion.�

Hayman Advisors Oct 14 - Upload a Document to Scribd

Musings on deflation ~ It's here ~ But what's next?

I've been thinking about a lot about exactly what is happening in the world economy these days. I decided to break down the actual facts and see what can be gathered from them.

Arguments in favor of deflation:

1) collapsing commodity prices
2) rising dollar
3) collapsing housing prices
4) falling stock prices
5 falling MZM

Those are very good arguments for deflation. However, there are weaknesses to each of these arguments.

1) commodity prices have collapsed over the past three months, but they haven't done so in a historical deflationary way. For example, farm prices began declining in 1927, and general prices didn't decline in the cities until 1930.
Why this is significant is that classic deflation takes time to build up for the same reasons that classic inflation takes time to build up. It simply doesn't happen this fast.
Now this doesn't preclude deflation happening today. It only means that what is happening is not a classic case of deflation.
An alternative explanation would be a massive deleveraging by global hedge funds. They invested heavily in commodities and they have now been forced to sell. This is not the same thing as deflation. It's more like the collapse in commodity prices and real estate in the late 1980's.

2) this is the weakest case for deflation. The most obvious thing wrong with it is the rise of the Japanese Yen. The Yen is not a reserve currency, yet it is rising against the dollar. Why? Because it is an unwinding of leverage.
I should also note that prices have not come down in he grocery store. If the dollar really was rising, don't you think that the price of food would come down?

3) collapsing house prices certainly have a deflationary effect, and is probably the strongest case for deflation.

4) while technically deflationary, this has never been directly associated with deflation. Stocks crashed in 1974 and 2002 without there ever being deflation.

5) now we get the most interesting, and applicable, part of the argument.
In fact the MZM is not falling significantly. So far only the rate has changed, not the overall stock. There was a far bigger decline from 2001 to 2004.
What's more, the Fed's credit is exploding. The deflationist argument that it won't make it through to the rest of the economy is interesting, but unproven. If deflationists are wrong in this regard then they are going to be wrong in a very big way.

6) we also have the massive bailouts. Deflationists say they haven't had any effect yet. But the fact is that they haven't really been rolled out yet. Today is the first day that we are seeing the full effects of the bailouts, and this is merely the leading edge.

So does all this prove that we aren't having deflation? Not at all. No one will be able to say for certain except in hindsite.
But it does give very strong case that what we are experiencing is deleveraging and no deflation.

Any comments from people other than Viper?

RE: Great Summary imo nm aussiebear NEW 10/27/2008 2:37:36 PM


RE: Forest and trees John... SuperCycleBear NEW 10/27/2008 3:21:34 PM
I think we're getting too close to the trees John and missing the forest.

There is absolutely NO doubt in my mind we are currently in the midst of one of the greatest deflationary episodes in history. To deny it is to dogmatically and pigheadedly deny the obvious. We would not have had the massive intervention to slow the financial collapse, if it were not the case. The result of that intervention .has produced the benign deflationary "LIST" you formed

However, as you point out it is not the typical deflation as few have resulted in (or from) changes to the global financial architecture - like this one seems likely to do.

As the architecture is going to change (but to what no one is quite sure, yet) so too will policies and strategies for navigating the fin. markets. Therein the difficulty lies. How can one take advantage of a new system if the details are to be 2nd guessed. I reckon it will involve a reduction in the role of the USD and a link to some extent to a tangible non financial asset that will give the medium of exchange some intrinsic value - hence the belief that gold will better than hold its real value over time - not nominal value but real value.

The USD rally is the final hurrah for the old system. It will be interesting to see who is going to step up to the plate and buy the USD$125 000 000 000 bonds.

A masterful summary

To make a reliable assessment of where we are and where we are going, we need to tie together some important evidentiary points. The evidence is there for all to see. The problem is that most lack the intellectual rigor and concept of time frames to put it together. I will endeavour to lead you through that process as simply as possible. Every analysis starts with a “where are we” and how did we get here précis. Doug Nolan of Prudent Bear lays out a masterful summary. As the consumer on which much of Asia relies, US is still the epicenter of the Asian financial picture. I urge you to read Doug’s summary carefully and reflect on what it means. Reading lists of numbers can be tiresome but there is simply no way for you to be informed investors without an understanding of the magnitude of the problem that the addiction to debt has wrought.

Where we are


Looking back, Total Non-Financial Debt (NFD) expanded $578bn during 1994. By 1998, NFD growth for the year had surpassed $1.0 TN. Non-Financial Credit increased $1.153 TN in 2001, $1.415 TN in 2002, and $1.676 TN in 2003, before reaching the $2.0 TN milestone in 2004. Incredible as it was, debt expansion then surged over the next fateful three years. Growth rose to $2.319 TN in 2005, $2.428 TN in 2006 and then to last year’s record $2.561 TN.

Importantly, this historic Credit Inflation inflated asset prices, incomes, corporate cashflows/earnings, government revenues, and various types of spending throughout the U.S. and global economy. It was a self-sustaining Bubble bolstered by ongoing Credit excesses, asset inflation and resulting purchasing power gains. But NFD growth slowed sharply to an annualized $1.726 TN during this year’s first quarter and then sank to $1.127 TN annualized during the second quarter. Credit growth is now in the process of collapsing.

To be sure, there were momentous effects to both the Economic and Financial Structures during the Bubble period between 1994’s $578bn Non-Financial Debt Growth and 2007’s $2.561 TN. It is also worth noting that Financial Sector Debt expanded $462bn in 1994 compared to $1.753 TN in 2007. Mortgage debt almost doubled in the six years 2002 through 2007 to $14.0 TN, while Financial Sector borrowings rose 75% to $16.0 TN. This Credit onslaught fostered huge distortions to the level and pattern of spending throughout the entire economy. It is today impossible both to generate sufficient Credit and to maintain previous patterns of spending.

It is worth recalling today that Wall Street assets began year 2000 at about $1.0 TN and ended 2007 at $3.0 TN. The ABS market surpassed $1.0 TN in 1998 and ended 2007 at $4.5 TN. GSE assets surpassed $1.0 TN in 1997 and ended last year at almost $3.4 TN. Agency MBS surpassed $2.0 TN in 1998 and closed 2007 at almost $4.5 TN. “Fed Funds and Repos” reached $1.0 TN in 2000 and ended 2007 at $2.1 TN. This Bubble in Wall Street Finance was one of history’s most spectacular Credit expansions. It also comprised the greatest use of speculative leverage ever.

Despite last summer’s collapse in private-label MBS and related markets, the faltering Wall Street Bubble nonetheless persevered up until the Lehman collapse. While it was problematic that overall system Credit growth had slowed markedly, there remained key sectors of Credit and risk intermediation that remained very much in expansionary mode. In particular, GSE-related obligations, bank Credit, and money market fund assets had expanded rapidly in spite of the subprime collapse. Importantly, the speculator community had maintained easy access to cheap finance. As I have noted often, despite the unfolding bust in mortgage and risk assets, market faith in “money” and the core of the system had held steadfast. This all ended abruptly three weeks ago with the Lehman filing.

Today, confidence has been shattered, and Wall Street finance is a complete and unsalvageable bust. The spigot for Trillions of finance - that for years fueled the asset markets and U.S. Bubble economy – has been essentially shut off and dismantled. In particular, Wall Street finance was a mechanism for intermediating higher-yielding riskier loans. This finance provided rocket fuel for both residential and commercial real estate markets – and the attendant wealth effects. Wall Street finance also grew into the key source of finance for auto purchases, student loans, Credit cards, municipal finance and various business enterprises. Many of these loans were of a risk profile unappealing to traditional bank lending – and, hence, provided the type of higher yields quite appealing to the speculator community.

And, importantly, as the stature of Wall Street finance grew its impact upon the real economy became embedded deep into the Economic Structure. Or, stated differently, risky loans came to play a major role in determining spending and investment patterns throughout the “Bubble” economy. Wall Street finance became a major direct and indirect generator of household incomes and corporate profits. Moreover, Wall Street finance came to dominate the flow of finance both in and out of the securities markets. Wall Street could create its own liquidity and funnel it into the U.S. and global markets – and earn unimaginable returns in the process.

The leveraged speculating community played such an integral role in the overall Credit Bubble and, more specifically, to the Bubble in Wall Street Finance. They were instrumental in both spurring financial sector Credit creation/leveraging, while directing this Flood of Finance to the asset markets. And the more the leverage and the greater the Flow to inflating markets, the higher the returns generated by this expanding pool of speculative finance. And the greater the returns, the more robust the “investment” flows into the hedge fund community – spurring more leverage and more potent fuel for additional self-reinforcing asset inflation. One of the greatest manias ever – surely The World's Greatest Episode of “Ponzi Finance” – is absolutely coming apart. And the wreckage is accumulating in all markets – everywhere.

Here at home, our maladjusted economic system will only be sustained by somewhere in the neighborhood of $2.0 TN of new Credit. It’s simply not going to happen. The $700bn from Washington would seem like an enormous amount of support. In reality, it’s nowhere even close to the amount necessary for systemic stabilization. To the $2.0 TN or so of new Credit required this year (and next) add perhaps as much as several Trillion more necessary to accommodate speculative de-leveraging (liquidations forced by huge losses).

How we got here

No solution to any predicament is possible without an examination of how we got here. Failure to recognise the causes and the key players instrumental in the serial bubble blowing we have seen since 1997 means a continuation of failed policies. Central banks led by US and Japan have failed to establish a proper credit regime. Greenspan’s insistence that he couldn’t recognise a bubble at the time it was happening and Bernanke’s subsequent acquiescence in setting rates below their real risk cost directly led to first the dot.com bubble and now a larger asset bubble, this time based around property assets. By fostering unsustainable levels of economic activity, secondary bubbles formed in other asset classes notably the stocks of players in the bubble game. Japan’s decade long obsession with near zero interest rates created the bubble in the carry trade which was directly responsible for the commodity bubble and the pain borne by consumers from $100 plus Oil. UK and Europe aped this behaviour by having their central banks too maintain rates at below real risk costs. As a general observation we know that over 60 central banks assisted with the marketing of US securitized paper with Asia taking its share particularly of GSE paper.

Today we have direct evidence that US, UK, Europe and the lands Down Under, Australia and New Zealand are using their central banks and their sovereign wealth funds as repositories for not only tainted securities but new securities specifically parceled to take advantage of these facilities. We have a one line announcement that the Australian Futures Fund has made unspecified advances to all the major Australian trading banks and last week the Australian Treasury created a $4 billion facility specifically to assist non bank mortgage originators. As Australia is one of the nine central banks participating in the US TARP program we can assume that these actions mesh with the wider approach of many central banks. It’s the same old game. None have yet faced up to the alternate of drastically reduced credit. None have yet contemplated life without a 90% LTV mortgage. Last year in the face of an obvious topping of housing markets, 46% of mortgage originations Down Under were of the 100% LTV variety. I suspect that many more obtained 100% status by other means.

Indeed most central banks are engaged as partners in a fascinating dance. One of the endearing lessons from the 30’s is that whatever remedies are available must be delivered conjointly and not piece meal. One out attempts at solutions for global problems merely focuses the attack, so all of the 9 central banks involved in TARP and the other 50 who assisted in the great securitisation sales are taking urgent lessons in the Tango. They are dancing together whether they like it or not!

Yesterday the Australian Reserve Bank triggered a storm in currency markets and a one day recovery in its equity markets with a 1% or 100 point cut in official interest rates. Aussie Reserve had at least been active in moving its rates upwards in baby steps but as Paul Volker pointed out many years ago, the baby steps don’t have an affect on markets so the Aussie bubble too kept inflating together with the rest of the world.

On 29 January I wrote for you in Financial Sense about the Uridashi trade that has been financing Australia and New Zealand’s property bubbles. It was a strange word unfamiliar to all but the elite London traders who originate most of these bonds. The crux of those articles was that the borrowings were extreme and essentially backed into the AUD-USD hedge (although the capital raising is done in NZ the NZ banks are subsidiaries of Australian parents). Uridashi today has seen the light of day in UK Telegraph and NZ talk shows as commentators are belatedly coming to grips with what you knew nine months ago. As holders rush to exit the weakening commodity currency of Australia and retreat into the relative safety of the Yen, this is what the pincer movement on AUD has produced.

A 29% drop in 2.5 months. Does that look like fun?

Parenthetically we ask how willing Japanese investors are going to be in rolling over this issuance when it rolls to maturity. Conventional wisdom is that they always take the 15 year compounding view but these are not conventional times. For Aussie and Kiwi exporters particularly miners and primary producers who have long term contracts denominated in USD, this is cause for celebration but if they are not cash flow positive, restrictions on bank funding may soon impact although that is not happening yet.

global rush to dollar liquidity is not deflation

Confusion reigns: A crisis-driven global rush to dollar liquidity is not deflation

In the crisis stage of a debt deflation, defined by Fisher and Minsky as a reduction in debt financing, credit and money market panic causes banks to stop lending and borrowing from each other, pay off existing loans to shore up their balance sheets, and build reserves against expected future losses. This creates a short term spike in demand for the currency in which the debt is denominated, in the current case dollars. To the uninitiated, this looks like monetary deflation. A strengthening currency and falling interest rates also characterizes monetary deflation. That can in time produce commodity price deflation, so the confusion is understandable. But don't be fooled.

Today the Wall Street Journal explains the recent surge in the dollar in dollar demand:
Dollar Surges Amid Hustle For Supplies Overseas
Oct. 7, 2008 (WSJ)

The dollar is in demand because many foreign banks engaged in short-term borrowing in dollars to fund various activities in recent years. Now, one normal channel for getting those funds or rolling over such debt -- borrowing from U.S.-based banks -- is gummed up, as banks are leery of lending to one another.

At the same time, banks world-wide are also looking to reduce their overall borrowing as part of a race to clean up their balance sheets. Where that borrowing was in dollars, they need dollars in order to repay it.

"There is a pyramid of leverage" in the financial system built up over years, says Mark Astley, CEO of Millennium Global Investments, a U.K. currency manager with $15 billion in assets. "This isn't going to be over in a couple of weeks."

The global demand for dollars pushed the U.S. Federal Reserve to announce a major expansion of its "swap" lines with other central banks, which allow them to provide liquidity in dollars to their local commercial banks. The Fed now has arrangements with nine other central banks, which together provide access to a total of $620 billion.

Still, that hasn't been enough to ease the squeeze. Some of the demand for dollars has spilled over into the currency markets. There, participants can buy dollars outright, or use derivatives known as currency swaps to exchange one currency for another at two different points in time.

Some investors say the appetite for dollars is akin to the demand for the yen. The yen surged against the dollar and the euro Monday; late in New York one dollar bought 101.61 yen, down sharply from 105.14 Friday.

The yen's ability to thrive stems from the fact that in better times, investors borrow in yen to take advantage of Japan's ultralow interest rates. But when volatility rises or investors need to cover losses elsewhere, they undo these maneuvers -- known as carry trades -- and buy back yen, boosting Japan's currency.

Meanwhile, by borrowing so much in dollars, foreign banks may have created "the biggest carry trade of all time," says Hans-Guenter Redeker, a currency strategist at BNP Paribas in London.
What will happen when this temporary dollar carry trade reverses? When?

The dollar will weaken rapidly. When? The de-leveraging of the "pyramid of leverage" will take from two to six months but not likely more than that.

Kicking the Debt Habit Cold Turkey

by Kurt Kasun September 03, 2008

Kurt Kasun is a contributing writer to GreenFaucet.com. The following is excerpted from the 08/10/08 Global MegaTrends Portofolio's Newsletter:

Things are about to get really bad. Rotating bubbles are now becoming rotating sector recessions as the positive feedback loops, created as money and credit growth ballooned over the last 25 years, have reversed and are now becoming negative feedback loops. I expect to see those 25 years of excesses to dramatically unwind over the course of the next few years. The evaporation of paper wealth will be breathtaking. A "buy on the dips" mentality has been replaced by "sell on the rallies." Declining house values will further hinder the finance sector which will impede the real economy, causing asset prices to further plunge. The tipping point for debt creation's positive impact has been reached and we can expect economic convulsions similar to what a drug addict experiences after kicking the habit "cold turkey."

"The credit crunch is morphing from an American-centered financial crisis into a global economic crisis," according to David Bowers of Absolutely Strategy. The policy of creating more money than could be put to productive use in the real economy that allowed rising asset prices would more than compensate for a lack of ‘real' wage gains in the real economy and for consumers to continue to borrow and spend more than they earn at an accelerating pace failed once the excess money began to flow to commodities rather than to real estate or stock prices.

Growth is now demonstrably slowing in all parts of the world. Central Banks around the world will be embarking on a campaign of lowering their interest rates. Participants in the US stock market, fresh off an artificially trumped up GDP restatement (trumped up due to the stimulus package and severe understatement of the GDP deflator), will take a while to realize that gains in the dollar are due to relative underperformance of other currencies and a massive liquidity contraction. The gains will be short-lived and will result in pain and agony as those investors are lured into another bear trap that will reveal itself once much of the sidelined money comes back into the market.

The fall in commodity prices will be wrongly interpreted as a reason for the economy to rebound and for stocks to rally. While the dollar will likely continue to rise over the short term it is ultimately destined to suffer the same disastrous fate as the other fiat currencies of the world. After the sucker's rally has run its course over the next few weeks or so, the reality of an unserviceable and un-payable debt overhang will set in and the second wave of financial calamity will ensue. This time around it will be the result of the effects emanating from the negative feedback loop coming from the real economy.

Scott Bugie of Standard & Poor's writes that the second phase of credit crunch could be severe: "The credit crunch is entering a second, 'post-subprime' phase where banks' loan books deteriorate more rapidly and capital-raising efforts might become harder, says Scott Bugie, credit analyst at Standard & Poor's. Loan book deterioration is starting to hit a wider array of financial institutions, as credit losses migrate from subprime into other sectors of household finance, such as credit cards, Alt-A and prime mortgages, and auto loans well into 2009,' he says.

Other mainstream economists are have also been sounding the warning trumpets: "The US is not out of the woods. I think the financial crisis is at the halfway point, perhaps. I would even go further to say the worst is to come," according to Professor Ken Rogoff who was chief economist at the IMF from 2001 to 2004 and who now teaches at Harvard. He goes on to say, "We're not just going to see mid-sized banks go under in the next few months, we're going to see a whopper, we're going to see a big one - one of the big investment banks or big banks."

In 2002 Dr. Marc Faber, author of the GloomBoomDoom Report and highly-sought guest for CNBC and Bloomberg TV, wrote a book titled, Tomorrow's Gold-Asia's Age of Discovery. Those who read the book and followed Faber's investment advice to invest in commodities and Asian and other emerging market equities have significantly outperformed those who primarily invested in US stocks (tech, consumer and financials). But Faber had recently cautioned against this "short dollar trade" as it had become stretched and crowded. He presciently warned investors late last year. More recently, referring to commodities, he said "Prices have made a peak...Whether that is a final peak or an intermediate peak followed by higher prices, we don't know yet. It could go lower."

He echoed similar sentiments in a Bloomberg TV interview this morning. I found his most recent market commentary, issued on August 20, 2008 titled, "Contracting Global Liquidity," quite compelling. He uses several charts to demonstrate how liquidity is contracting, the dollar is strengthening, commodities are declining, and what the relationships that exist between them predict for the future. He writes:

"In sum, credit growth and liquidity are contracting, a vicious economic downturn is about to unfold ( China could surprise on the downside and put additional pressure on commodity prices) and asset markets are still high by historical standards and, therefore, remain vulnerable. I would use equity rallies as a selling opportunity and further weakness in gold as a buying opportunity for long term holders with significant cash and cash flows."

Faber has an enviable track record over the long, intermediate and shorter term. Not many investment strategists can boast of getting the market right over these three terms. He is an open-minded contrarian who is not afraid to change his views. He was way in front of the investment community predicting the rise of China and commodity prices six years ago. He correctly wrote that the US currency and stock markets would relatively outperform others last year. And he got the April-May S&P 500 rally to 1440 right also.

The one longer-term trend Faber appears to have the most confidence in is the "long gold/short the DJIA" trade that has been working, despite the recent pullback, since 2001. Over the intermediate term he is a looking for what can be described as nothing less than a US stock market crash, perhaps by the end of this year.

Rather than the US markets leading the rest of the world higher, the evidence points toward the rest of the world leading US markets lower. The global slowdown had begun in earnest. The US is now more dependent on world growth than the world is reliant upon the US. This is especially true since the US consumer is seeing his credit cut off and US banks and financial institutions suffer the effects of the second wave of the credit crunch. Once the relief rally has run its course and investors see that the US economic rebound has not staying power and only worn out consumers trying to pay off 25 years of accumulated debt, the dollar will rejoin the ranks of the other fiat currencies and resume its decline versus the price of gold.