Trade Wars Yet Again?

Wasn't everyone saying that the RMB repeg would end the threat of trade wars threats with Asia for at least a while? Well here we are, three day later pondering this:

Japan says may impose duties on US goods.

Japan is considering imposing retaliatory duties on U.S. goods to counter subsidies paid by Washington to companies under an anti-dumping program ruled illegal by the World Trade Organization, Japan's top government spokesman said on Thursday.

The Nihon Keizai business daily reported on Thursday the tariffs could amount to some $76 million on U.S. steel and ball bearing products, and would be imposed from September.

"We are considering the move, in line with WTO regulations," Chief Cabinet Secretary Hiroyuki Hosoda told a news conference. But he declined to say when and what goods would be subject to the levies.

It would be a first for Tokyo to impose retaliatory duties.

The amount of money is not that significant. The fact that it is happening so soon after the RMB repeg is significant, and the fact that it would be a first for Tokyo to impose retaliatory duties is significant as well.

The WTO has declared the program to be illegal in a challenge brought by the EU, Canada, Japan and other trading partners.

Tokyo plans to keep any levies in place until the Byrd amendment is repealed, media reports said. In June, Tokyo called on Washington to repeal the amendment by the end of July.

The Bush administration has repeatedly proposed repealing the Byrd amendment, but it remains popular with many members of Congress despite the WTO ruling.

What's next? Perhaps we will see the "currency manipulator" threat before anyone thinks likely, given the rapid pace of things lately.

let's now review a chart posted here twice before.
Here goes....



Should anyone really be surprised by this sudden protectionist talk?

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

The Optimist

Lets consider an optimistic viewpoint entitled A CARBORUNDIUM - HOW TO HEDGE A RETIREMENT? written of course by "The Optimist".

Now I am not sure why an optimist would be concerned about inflation, deflation, stagflation, how to hedge, or for that matter anything else, but here it is in black and white:

The Optimist apologizes for presenting a topic which will be of little interest to investors who want to primarily protect against deflation. If the USA is on a path to deflation in the not too distant future, then there is no need to worry about hedging a retirement, or even to consider various investment strategies. A deflationist would need only to convert all assets to cash, or to a super safe T-Bond equivalent, and then wait for precipitously plunging prices of everything to multiply the purchasing power of cash. A retirement or Social Security check each month for a fixed number of fiat dollars would automatically gain purchasing power during a deflationary contraction. There would be no need to do much more investment work than to sing another verse of "Don’t worry - Be happy" as falling prices everywhere magnify the wealth of cash equivalents. The ease of positioning investments for deflation makes it tempting to convert to that belief system, but the Optimist will not yield to the easy side of the force. For the last 70 years, inflation has been the American Way of truth, justice, and financial integrity. The Optimist steadfastly continues to support that proud and time honored heritage.

The optimist "will not yield to easy side of the force" and steadfastly continues to "worry and not be happy" because inflation is a proud and time honored heritage. Good grief! Just what kind of optimist is that?

Furthermore the optimist advises people that "A deflationist would need only to convert all assets to cash, or to a super safe T-Bond equivalent, and then wait for precipitously plunging prices of everything to multiply the purchasing power of cash."

I am trying to figure out if that advice is really for optimists or pessimists or just plain worriers from both camps. Consider the following:

1) Just who would the deflationist sell out to and at what prices if everyone attempted it at the same time? Perhaps that's optimism that it could be done. Then again, if one was optimistic why would one be cashing out at all? Is "The Optimist" really an optimist or a pessimist? I guess I am generally confused.

2) The optimist being what he is, fails to consider that if most people converted their assets to cash and paid off all their debts would not have a dime left. Indeed many would be in a hole. Debt as a percentage of GDP is staggeringly high. People have enormous credit card debt, housing debt, obligations, etc. Just how much money would be left after "cashing out" (if anything) and could that possibly support retirement? Now an optimist might think that everyone could cash out and that would support retirement, but then again an optimist would see no need to do so in the first place. So once again I am confused.

3) The Optimist writes "Consider the impact if the CPI does not move up as fast as the real cost of living, as the Optimist considers likely". There you have it. That is evidence that the optimist needs to change his name to "The pessimist" on the other hand it conflicts with pervious optimistic statements.

Now perhaps this was all tongue in cheek by the optimist. Then again perhaps this is all tongue in cheek by me. Let's continue:

The "****ist" since we have no clear cut evidence of "whichisittism" writes:

After considering the monochromatic offerings the Optimist can present, however, readers might shout Nuts!, and bolt from this discussion. This is the best the Optimist can do. Buy more silver and gold. That seems to pass most of the "Does it walk like a duck?" test. If the retirement value is lost, or other investments deteriorate, or the house is destroyed, equity will remain in the gold and silver, and that equity would be easily available to use for financial reconstruction. The annual costs of owning silver and gold are relatively low, the value of silver and gold will probably rise faster than inflationary increases in costs, and silver and gold will still be there for you when many companies are fighting for position at the take a number machine outside the bankruptcy courts.

We have a leap from nowhere to "buy more silver and gold". Hmmm, is that optimistic or pessimistic? How about this? "The annual costs of owning silver and gold are relatively low, the value of silver and gold will probably rise faster than inflationary increases in costs, and silver and gold will still be there for you when many companies are fighting for position at the take a number machine outside the bankruptcy courts."

I sense general optimism in that a recommendation was made that gold and silver will "probably" rise... but what's with this probably stuff? What kind of real optimist writes "probably"? Furthermore what kind of optimist thinks that "many companies are fighting for position at the take a number machine outside the bankruptcy courts." Bankruptcy courts? Is that optimism?

Once again let's proceed looking for additional clues.
The optimist writes: "the Optimist can confess that he did briefly harbor another thought. If the coming bad times will coincide with rising long term interest rates, then a simple hedge would be to sell short a T-Bond future, and to subsequently just roll it forward. As with most simple solutions, however, his one has a potentially fatal flaw. Long term rates might not drop! Despite rising real inflation and a world wide economy that is booming (that description mostly applies to Asia of course), long term rates have persistently declined instead of rising as would be rationally expected.".

The optimist is worried about bad times with a fatal flaw? The optimist is briefly harboring bad thoughts? I am sorry, that is the final straw. The asterisks just have to go. The optimist is clearly not an optimist or an "****ist" but a deeply confused pessimist.

Is that so bad?
Personally I think not.
Besides, I kind of like the guy.
It's not easy for a bona fide pessimist to stick his neck on the line asking for comments and in bold typing "Readers will tell me where to go!".

Damn. That's optimism if I ever saw it!
PS. Jim, this was all supposed to be in good fun.
Hopefully you took it that way.
By the way, I am "mildly optimistic" on gold and silver myself, currently long both.
Cheers.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Gold and Silver Update

On June 30th we discussed the Mysterious Gold Order.

At the time there was a lot of excitement over this "order". Well yesterday over 26,000 August 445 gold calls bit the dust. I have not heard anyone talk about this trade now for at least a couple weeks.

This was the call back on the 30th....
From a seasonality standpoint, I believe those calls expire just a tad early for the normal August rally. OTOH, if gold can get a strong rally going in the meantime, the seller of those calls is going to be sweating big. Don't count on it.

Now the question is: Did someone "know something" or not. Whatever they might have known was surely worthless (at least as far as gold is concerned). Two things come to mind:

1) London Terrorist attacks
2) RMB repeg

What is interesting about these events is that if you asked any trader how gold might react to those, I am guessing the response would have been overwhelmingly wrong. Even today most everyone on the stock boards I partake in is shaking their heads over the YEN.

I believe the YEN explanation is righthere.

On June 28 we had a Spotlight on Silver. I do not have a fresh chart to show but a quick glance shows that nothing much has changed since then. We are still at or just below that triangle, having bounced from a breakdown right back up into it again and playing around at the bottom edge right now. Should this chart break down, a quick check shows the 200 EMA is still around 6.00.

That said, seasonality is now back in play on both gold and silver.
FWIW (and this should not be construed to be investment advice) I hopped back into silver this AM with December bull call spreads 720-750 for 10.5

Last week I bought deep ITM DEC gold 410 calls at slightly better prices than one could get today. Again this should not be taken as investment advice. In both cases I have know risk. Should gold do a quick pop, I may consider writing some OCT calls against the position converting into OCT-DEC Bull calendar spreads.

The biggest risk on both of these plays is the strength of the US$.
The biggest factor on the buy was seasonality.
Calls and spreads were selected to minimize the risk and there is plenty of time between now and the DEC expiry (in NOV).

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

The great "Flation" debate - What's coming and how to profit from It.

I will be hosting a live session about "flation" on FxStreet.com with the theme of The great "Flation" debate - What's coming and how to profit from It. The date/time of the session is Thursday, July 28 at 15:30 GMT 11:30 EST. Click here to register or to submit a question in advance. Get your questions in now and plan on being there!

On the day of the session you can enter the live session using this link. To access the chat room, please choose a nickname and press the "connect" button. When you enter the room, you may be adverted with a security warning. If that were to be the case, just answer YES.

For those reading this blog regularly, much of the discussion topic has been covered in previous articles but hopefully I packaged it up in a nice neat way (but it is long). I have also added some new comments and ideas from Stephen Roach, David Rosenberg at Merrill Lynch and others.

During the session I will field questions submitted in advance as well as live questions submitted real time. If you have burning questions now is your time to ask them. Without further ado, here is the article for discussion:

The debate over inflation, deflation, hyperinflation, disinflation, stagflation and just plain "flation" have been raging now for months on end and if anything have heated up recently. Ok Mish, let's step back. Why should anyone care? If we are going to hell in a hand basket when the housing bubble pops (and it will) does it matter how we get there?

Yes, it does matter. Steps need to be taken to protect your money and smart investment choices certainly differ as to where we are headed and how we get there. In other words it is best to be positioned for the type of "flation" that is about to occur.

Before we proceed it is best to define some terms.
The classical definition of inflation and deflation from Ludwig von Mises
The Theory of Money and Credit is as follows:

"In theoretical investigation there is only one meaning that can rationally be attached to the expression inflation: an increase in the quantity of money (in the broader sense of the term, so as to include fiduciary media as well), that is not offset by a corresponding increase in the need for money (again in the broader sense of the term), so that a fall in the objective exchange value of money must occur. Again, deflation (or restriction, or contraction) signifies a diminution of the quantity of money (in the broader sense), which is not offset by a corresponding diminution of the demand for money (in the broader sense), so that an increase in the objective exchange value of money must occur. If we so define these concepts, it follows that either inflation or deflation is constantly going on, for a situation in which the objective exchange value of money did not alter could hardly ever exist for very long."

That snip was from an excellent article entitled SCYLLA & CHARYBDIS THE SCOURGE OF MANKIND by Douglas V. Gnazzo.

Mr. Gnazzo goes on to write:
And now the tricky part: a definition of hyperinflation. Supposedly they, whoever they are, have not decided on an exact definition. Most often it refers to the monetary condition where the supply of money cannot keep up with the rising demand for money, which in turn causes prices and interest rates to go up as well.

But there is more to it than that. For now, suffice it to say that hyperinflation is inflation that has run amuck, the creature that is no longer under the master’s restraint. The following discussion will examine the two beasts: Scylla and Charybdis: deflation; and hyperinflation; and if there is an “unless” scenario.

In the above definition it is stated that inflation is “an increase in the quantity of money (in the broader sense of the term, so as to include fiduciary media as well), that is not offset by a corresponding increase in the need for money (again in the broader sense of the term), so that a fall in the objective exchange value of money must occur.”

Fiduciary media – sounds pretty impressive but it’s not. Fiduciary media is a fancy word for money substitutes: stuff that isn’t actually money, but represents claims on money. All those checks we write would be an example; all those computer entries on the ledger would be another.

Mr. Gnazzo goes on to explain monetary inflation, price inflation, asset inflation, savings, credit and other terms. I will accept all of the definitions as stated and discussed by Gnazzo. Stagflation is a wimpy term that Gnazzo did not address but is generally used to describe rising interest rates and a stagnant economy. Disinflation, another term Gnazzo did not define is generally accepted as a slowdown in the rate of inflation. Finally, dictionary.reference.com defines reflation as "inflation of currency after a period of deflation".

Hopefully that is enough terms as I just can not take any more!

OK Mish, what investments are best and when?
Let's make a grouping of four, calling them Spring, Summer, Autumn, and Winter otherwise know as the Kondratieff Cycle:

Spring:Inflation/Reflation - Bonds and interest rate products do poorly, commodities do well
Summer:Hyperinflation/Stagflation - commodities do well, most everything else is horrid
Autumn:Disinflation - bonds and stocks both do extremely well, commodities do poorly
Winter:Deflation -Treasuries and interest rate products do well, most everything else horrid

Following is a chart of the Kondratieff Cycle (K-Cycle for short).



Notice where I placed the arrow.
Certainly if we are headed into Spring, and even more so into summer the very last place you want to be is in treasuries and interest rate products in general.

If we are headed into Winter or are already there, the last thing you want to be doing is shorting treasuries. You also do not want to be long equities or long much of anything for that matter.

OK Mish what gives? If we are headed into Winter as you suggest, why are stocks rising pretty much world wide and more importantly why are commodities currently doing so well?

Those are good questions as well as important questions.
Please bear in mind that not every country is on the same cycle at the same time. Japan has been in Winter (deflation) for going on 18 years and may indeed be coming out of it soon. Note too that K-Cycles apply best to capitalistic economies as opposed to command economies like China.

Also note that the CRB commodities index is very heavily weighted towards energy. Oil, and energy products in general) are subject to peak oil constraints as well as geopolitical factors. One can not blame peak oil shortages or weather or geopolitical concerns as inflation. Indeed soybeans skyrocketed up a couple of years ago on bad weather and soybean blight and crashed last year on perfect weather. It is totally nonsense to blame all rising prices on "inflation" and dismiss all falling prices as "productivity" as some prominent names have done. Indeed if one looks at corn, soybeans, lumber, sugar, cotton, and coffee, one would be very hard pressed to make a case for sustained inflation.

Finally, please note that the FED has been well aware of the problems of Japan and acted in advance (by slashing interest rates to 1%) to prevent the US from falling into deflation. Greenspan in all his hubris, declared the defeat of deflation. That alone should scare those believing in inflation half to death. No one has been more wrong, more often than Greenspan.

Greenspan accomplished nothing more than creating additional bubbles in junk bonds, equities, and most importantly housing. Those bubbles will be deflated away, not inflated away, or every Tom, Dick, and Harry chasing real estate at absurd prices will be correct. I view that as very unlikely to say the least.

In short, it is highly unlikely that we have completed the Winter deflation cycle. It is far more likely we have temporarily interrupted the cycle. This has led to a phenomenon that I call "a False Spring" and it has also led to a preponderance of conundrums everywhere. Given the length of the Autumn disinflation and massive stock market bubble along with it, it also seems highly unlikely that we have wiped away those excesses in a few short years since the Naz bust. Indeed, given the fact that consumer debt and optimism were never flushed, "highly unlikely" does not seem anywhere near strong enough. When the housing bubble pops, our early Spring Groundhog will be frightened by his own shadow and go running for cover. Liquidity will dry up and there will be hell to pay for the excesses of the past 20 years.

As of right now we are still in a "crisis of excess liquidity" but remember that liquidity and complacency are both at their maximum right before a crash. Is 1929 too far back to remember? I am afraid that it is. However 2000 should not be, but apparently it is as well. We have transferred a stock bubble into a housing bubble where people are paying absurd prices for condos and houses sight unseen. That is the affect of the "False Spring". The consequences will be devastating when the housing bubble pops.

For additional discussion of the K-Cycle and the recent "False Spring" please refer to The Kondratieff Cycle.

Mish, is there any more evidence to support your theory that we are headed into Winter as opposed to having just experienced Winter and are now heading out of it?

Yes indeed there is.
I discussed the current situation at length in
Same Data / Different Interpretation
The deflation debate heats up
Inflationists Respond

For those lacking in time to read all of those articles, let me sum up the basic scenario that I envision that no inflationist has yet to respond to in any meaningful way:

Here is the nut hyperinflationists need to crack:

1. Falling home prices
2. Falling wages
3. Stagnant employment or rising unemployment
4. Slowing world economy
5. No incentive for the FED to bail out consumers at the expense of banks
6. The K-Cycle is not likely to be defeated by throwing more money at the problem.
7. At some point lenders refuse to lend or borrowers stop borrowing. That time will be at hand when housing plunges. Look at current events in the UK as a prelude for what will happen here.

Here are the inflationist scenarios as best as I can since no one else seems willing to take it on.

Here are two scenarios that will work:
Scenario A:
A1)Increasing demand for commodities from China.
A2)Housing prices stay strong and economic activity picks up worldwide.
A3)US wages rise
A4)Rents rise
A5)Demand for goods in the US stays strong
A6)Demand for goods in Europe picks up
A7)Demand for goods in China picks up

It may not take all of those but it would take a lot of them to be consistent with sustained inflation.

Scenario B:
B1)Increasing demand for commodities from China in the face of a US housing bust
B2)Consumers keep spending money and banks keep lending even as asset prices fall
B3)Should consumers stop spending in the face of job losses associated with the housing bust, the FED goes on a mad printing spree.
B4)Since the FED can print but not force the consumer horse to drink (increase borrowing), a "helicopter drop" is issued (whereby Congress passes laws that literally gives money away to consumers)
B5)The "helicopter drop" is done in the US only and other countries refuse to finance it. (If everyone did it the US$ would not drop).
B6)Banks and other creditors have no say in this and are destroyed along with the FED in the hyperinflation that takes over.
B7)The consumer is bailed out at the expense of big creditors like Citycorp, American Express, Visa, MasterCard, etc.
B8)The business cycle is defeated. There will never be a recession again.
B9) Consumers never need to save again but are bailed out by rising asset prices.

Again it may not take all of those but it would take the crucial ones: The FED and Congress acting together to bail out consumers at the expense of creditors. It would probably have to be a US related thing only to force the dollar to get smashed vs. other fiat currencies.

That is what I am looking for: A logical scenario that addresses the full implications of a housing bust, or some sort of scenario that addresses the full implications of a FED that voluntarily produces hyper-inflation.

I have three times challenged hyperinflationist Puplava to a debate on these issues. He has not responded. On Puplava's July 23rd netcast he was asked why he would not respond to the debate. Puplava replied that there was nothing to respond to... that he would not respond to a list of items .... and that we have not seen deflation since the great depression. Here is a direct quote "In order for me to respond there has to be something to respond to.... you can not respond to laundry lists. There is nothing of merit to respond to".

His response to the question was curious to say the least. I responded to a 14 point "Laundry List" of Puplava's in Same Data / Different Interpretation. I also responded to a second Puplava "Laundry List" in The deflation debate heats up where Puplava gave his list of ten reason why hyperinflation is coming. Are laundry lists are only acceptable if they support hyperinflation viewpoints? I also found it interesting that Puplava had praise for Precther who sees the issue as a matter of timing and that hyperinflation is eventually coming "It's just a matter of timing".

Yes indeed. It is just a matter of timing. I agree with both Puplava and Prechter on that. Some people think the business cycle (K-Cycle) can be defeated others do not. Hyperinflationists say we have not seen deflation since the late 20's early thirties therefore we are not going to see it. Hmmm. Given the length of time of the cycles, might it just not be about time for another K-Winter?

The mistake of hyperinflationists is projecting into the future what they see in front of their noses, as if it can go on forever. Note too that in a complete K-Cycle inflation is rising for three of the four periods so by definition inflationists are right most of the time. By the time we hit the third season (Autumn) there are no (relatively speaking) deflation believers left and we are scorned by the masses. Hyperinflationists simply will not look at the number one cause of deflation: an unsustainable credit boom that inflates illiquid assets such as real estate, and produces overcapacity on all or nearly all manufactured goods.

In that regard, housing has boomed and is now falling in Australia, the UK, and some places in China. Topping signs are also present right now in the US. Overcapacity is rampant in China on nearly all goods. Those are the seeds of deflation, not inflation.

Following is a chart showing where the US currently is in the housing cycle.


Please mentally move that arrow to the exact top and that is about where I think we are. What is interesting about housing bubbles is that most of the time they are local. One region peaks, and on a different time scale another one peaks. When the Oil boom ended and housing crashed in Texas it did not affect prices in Chicago, Boston, Miami, or LA. Take a look at us now. We have property bubbles in California, Florida, Las Vegas, Chicago, Milwaukee, Minneapolis, and other cities too numerous to mention. When was the last time we saw speculation in real estate this high?

The answer is the mid to late 20's, especially Florida. We have land speculation not seen since then. Unbuildable swamp land in Florida is once again being sold for tens of thousands of dollars. People are buying houses and condos sight unseen. Here we are staring into the jaws of an enormous property bust (one that even the hyperinflationists see) but all hyperinflationists can see is "We have not seen deflation since the early 30's". No deflation since the 30's huh? Is it a coincidence that we have not had huge real estate speculation, mammoth overcapacity, and an enormous credit bubble since then either? I think not.

Here is my take.
Hyperinflationists refuse to respond to the implications of a housing bust in conjunction with overcapacity and a blowoff top in credit speculation for one reason only. They can't (at least not in any logically believable scenario).

The biggest argument the inflationists seem to have is money supply: it never seems to go down. But... Can money supply rise and prices still fall through the floor? Of Course! Witness Japan. Japan suffered the deflationary affects of a property bust for the last 18 years even though the Japanese government was printing like mad. Japan went from being one of the world's biggest creditors to a nation with a national debt about 250% of their GDP.

With that thought, let's once again return to the classical definition of inflation and deflation from Ludwig von Mises as shown earlier:
"In theoretical investigation there is only one meaning that can rationally be attached to the expression inflation: an increase in the quantity of money (in the broader sense of the term, so as to include fiduciary media as well), that is not offset by a corresponding increase in the need for money (again in the broader sense of the term), so that a fall in the objective exchange value of money must occur. Again, deflation (or restriction, or contraction) signifies a diminution of the quantity of money (in the broader sense), which is not offset by a corresponding diminution of the demand for money (in the broader sense), so that an increase in the objective exchange value of money must occur. If we so define these concepts, it follows that either inflation or deflation is constantly going on, for a situation in which the objective exchange value of money did not alter could hardly ever exist for very long."

If one ponders the Mises definition, then one can finally relate to the 18 year deflation in Japan while Japan's national debt rose from zero to 250% of GDP.

In short, the FED can print but it can not force people to borrow or banks to lend. In a housing bust just what demand will there be for money from people that have jobs, that banks would be willing to lend to, in an ocean of overcapacity? The bottom line is that we are indeed headed for a Japanese style liquidity trap as explained in UK / US Housing and the upcoming liquidity trap.

In Which Flation Is It? Pater Tenebrarum discusses viewpoints of Austrian scholar Frank Schostak in a Mises article entitled "Does a falling money stock cause economic depression?" ... an excellent article with many charts depicting the 30's depression's macroecnomic and monetary data - which prove, beyond a shadow of doubt, that the Fed was priming the pump madly at the time, contrary to popular mainstream economic misconceptions. but it didn't work - a deflation of both the money stock and bank credit, as well as a vicious price deflation ensued. note that prices at one point registered an aggregate annual decline of over 10%). as an added bonus, there's a chart detailing the change in the BoJ's holdings of government securities during the 1990's - which contradicts Saville's contention that Japan relied 'mostly on fiscal deficit spending' as opposed to monetary pumping. it relied in fact on both.

Consider these supporting opinions from highly respected economist Stephen Roach:

In Inflation Phobia Stephen Roach writes:
Two years ago, the core CPI slowed to just 1.2% in the six months ending February 2004 before rebounding quickly back toward 2% by the final quarter of the year. For reasons noted above, in the face of a China slowdown, downside risks to the core CPI hint at an outcome that might even go beyond the concept of just a deflation scare. The next time, it may be the real thing. So much for inflation phobia!

In Inflation Convergence Stephen Roach writes:
the increasingly powerful forces of worldwide pricing convergence suggest that domestic attempts to exercise pricing leverage will encounter stiff global headwinds in a climate where non-US world inflation is likely to remain subdued. Consequently, barring the unlikely reversal of globalization, I continue to believe that persistently low global inflation will prevent a meaningful deterioration on the US inflation front. Needless to say, that has especially important implications for Fed policy and fixed income markets -- underscoring what I still believe could be a surprisingly bullish outlook for bonds.

Finally, in No Bottlenecks without a Bottle Stephen Roach writes:
At work, in my view, is the globalization of disinflation. Our old closed-economy models have been rendered increasingly obsolete by the emergence of far more powerful cross-border influences on pricing.

With those three article Roach joined the deflation camp. Many treasury bears are convinced the capitulation of Roach and Bill Gross, in conjunction with the repeg of the RMB by China marks the beginning of the end for US treasuries and the US dollar. The plain fact of the matter is there are forces at work that provide powerful resistance to any sort of sustainable inflationary bout.

David Rosenberg, chief ecomomist for Merrill Lynch would also seem to agree.
Every week Mr. Rosenberg puts out "Dave's Top Ten" 10 major macro themes of the past week. Following is point number 5 for the week of July 22, 2005:

5. We do not know why so many believe that the Fed is so accommodative:
Yes, credit spreads are tight but we're not convinced that is saying
anything about the state of monetary policy. The real funds rate is now in
positive terrain based on any inflation measure you want to use at a time
when there is still an output gap—which we estimate at 1.5%—does not
represent a loose monetary stance. That the economy is cruising along
near potential and core inflation trends are low and showing signs of
rolling over. The dollar has firmed this year, notwithstanding yesterday's
FX move by China. Raw industrial commodity prices are well off their
highs. And the money supply numbers, which fell sharply on the July
11th week, are extremely well contained—y/y growth in M1 now at
0.6%; 3.5% for M2; 1.1% for MZM and 4.9% for M3. These are not the
conditions for higher inflation and not the conditions, in our view, for a
sustained selloff in the bond market.

The rest of the list is very interesting as well. I highly recommend reading it.

With those excerpts from various highly regarded economists, let me quickly sum up the three biggest headwinds for inflation:
1) a busting of the housing bubble
2) global wage arbitrage
3) overcapacity

Those headwinds are so formidable that calls for hyperinflation in the face of them seem silly at best. If the world's biggest reflation effort in history along with interest rates at 1% failed to produce hyperinflation, it is borders on nonsensical to believe that a housing crash (the single most deflationary thing I can think of) will bring about hyperinflation.

As usual, timing is everything but the odds seem overwhelming that we will see a destruction of credit and deflation in asset prices before any possible hyperinflation scenario.

Investments that will do well in a deflationary environment are as follows:
1) Treasuries
2) Gold
3) Cash

On the aggressive side, shorting stocks in the financial sector AFTER the housing bubble pops should be a winning strategy. One might also consider investing in interest rates futures in the US and UK. Multiple cuts are already priced in for the UK right now but buying the dips in Short Sterling futures (UK interest rates futures) may be a good idea. I am in Sept 2007 futures as well as a stash of Sept 2006 calls that are now quite deep in the money.

An extremely conservative play would be investing in a ladder of US treasuries 1-yr, 2-yr, and 5-yr, rolling them over as they expire. US treasuries are the single most universally despised asset class right now. Sentiment against them is extreme. It would indeed be fitting if that was one of the best performing asset classes over the next several years. The caveat will be that treasuries do well in Autumn and Winter. When Spring finally does come you better be out of them.

Japan will likely head out of deflation first. At some point shorting Japanese government bonds will be an enormous winner. The same case can be made for US treasuries but not until we go thru Winter. That can be a long time as evidenced by Japan.

Also remember the primary goal in a deflationary period is to protect what you have. He who loses the least will win the most.

Let me offer one final thought from SCYLLA & CHARYBDIS THE SCOURGE OF MANKIND.
History is replete with bouts of both hyperinflation and deflation. One distinction that history shows, however, is that hyperinflation ends the life of a currency – it no longer is accepted as the medium of exchange. Although deflation is wrought with pain and suffering, defaults, bankruptcies, job losses, depressions, etc.; the currency is not destroyed or ended. The slate of debt is wiped clean, and the game begins anew, another cycle of boom and bust in paper fiat land. Hyperinflation destroys the currency; deflation prolongs the life of the currency. The first ends the currency game; the second allows the game to continue.

Given that hyperinflation will not only "end the game" as Gnazzo cleverly puts it, it would also put the FED out of business and bail out debtors at the expense of big banks like JPM and Citycorp. Is that really likely? I have no doubt the FED will try and inflate. The operative word is "try". Even though it is rational to believe they will try, it is not rational to believe they will continue to inflate if it means "the end of the game". The rational conclusion therefore is that the Bernanke "Helicopter Drop" theory is nothing more than a big bluff.

He is the bottom line: The vast preponderance of evidence suggests that we are heading into or are already in K-Winter. Winter was interrupted by a "False Spring", the FED will not "End The Game" by bringing about hyperinflation, and the normal boom bust K-Cycle is still intact.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Gasoline Prices are Starting to Bite

USA Today is reporting that Resale values tumble on Large SUVs. The reason should be obvious: higher gas prices at the pump. Let's take a look:

SUV and pickup owners - already stung by rising gasoline prices - are paying another penalty when it comes time to trade in or sell: falling resale values for the gas-thirsty vehicles.

The resale values of large SUVs and pickups are slumping in response to a supply glut, higher gasoline prices and lower sales of new SUVs and pickups.

"If the rebate on a Chevy Suburban goes up $1,000 this month, usually the Suburbans sitting out there in our auction lane all of sudden lost maybe $500 worth of value," said Tom Kontos, chief economist at Adesa, a firm that tracks wholesale used vehicle prices.

AutoTrader.com, an online vehicle seller, has 100,000 more SUVs listed in online classified ads today than a year ago, spokeswoman Louise Barr said.

This can not bode well for the lack of innovative new designs at GM and Ford. Yes, GM is reporting record month over month sales increases but from depressed levels and at what cost? If they start cranking out more SUVs who will want them? Are they capable of cranking out anything else that people might want? Even if they can, can GM make a profit on it? How much of these sales bite into future demand as customers are now expecting "employee discounts" everywhere you look?

If that news is not bad enough, on July 25th this announcement came from Paul Krugman at the New York Times: Toyota, Moving Northward.

There has been fierce competition among states hoping to attract a new Toyota assembly plant. Several Southern states reportedly offered financial incentives worth hundreds of millions of dollars.

But last month Toyota decided to put the new plant, which will produce RAV4 mini-S.U.V.'s, in Ontario. Explaining why it passed up financial incentives to choose a U.S. location, the company cited the quality of Ontario's work force.

Is the quality of the US work force that much worse than Canada's or is this all a smokescreen for something else? Since I do not have that much faith in inate Canadian ability vs. the US, I think something else is happening.

This kind of reminds me of the opening lines of
For What It's Worth (a 60's protest song, taking the liberty of changing one word).
There's something happening here
What it is is exactly clear...
At any rate, Krugman nails it with his continuation as follows:

Canada's other big selling point is its national health insurance system, which saves auto manufacturers large sums in benefit payments compared with their costs in the United States.

So what's the impact on taxpayers? In Canada, there's no impact at all: since all Canadians get government-provided health insurance in any case, the additional auto jobs won't increase government spending.

But U.S. taxpayers will suffer, because the general public ends up picking up much of the cost of health care for workers who don't get insurance through their jobs. Some uninsured workers and their families end up on Medicaid. Others end up depending on emergency rooms, which are heavily subsidized by taxpayers.

Funny, isn't it? Pundits tell us that the welfare state is doomed by globalization, that programs like national health insurance have become unsustainable. But Canada's universal health insurance system is handling international competition just fine. It's our own system, which penalizes companies that treat their workers well, that's in trouble.

By the way, it's not just gasoline prices, its gasoline prices, health care prices, education prices, outsourcing, property taxes and numerous other factors. Unless wages improve we are headed for a brutal consumer led deflationary recession. Hint: wages are not going to improve.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Universal Agreement

Are 100% of the people ever correct about an investment idea?
Well 100% is a tough row to hoe but what about 98% or so?

As best as I can tell from reading dozens of articles and posts on stock boards and discussions with friends, with a single exception (via an email discussion as opposed to a public post) nearly everyone agrees with this article put out today in Commentary by Ryan Detrick on Schaeffer Research.

Here is the relevant snip:

Running under the radar to most investors was word out of China that the government would revalue its currency, the yuan. In my opinion, this was rather big news. The plan calls for a revaluation of the yuan by 2.1 percent and a shift to a currency basket (of which the components have not yet been decided). This move was much expected, and the currency markets over-reacted to a degree yesterday to the "small" move. The reason for the violent moves in some markets is that this move is being viewed as the first of potentially many more adjustments to the yuan. In fact, I've read some economists are calling for a yuan revaluation of up to 50 percent. Makes that 2.1 percent move look pretty weak doesn't it?

An interesting discussion we had here on the floor today is was this just a move to satisfy Washington? Will this move be followed up with another move a year from now? How many more moves could come much sooner? Of course I don't know, but it's worth some thought.

The big loser when you start revaluing the yuan is the U.S. dollar. This is a sign that one of the largest buyers of U.S.-denominated assets is beginning to lose its interest in such assets, this is the reason bonds took such a beating yesterday.

A 50% drop in the value of the dollar huh?
I would be curious to see a list of economists suggesting that and exactly what their credentials are. Here is the key sentence though:

"The big loser when you start revaluing the yuan is the U.S. dollar."

Hey Bernie, got a sentiment reading on that for us?
What percentage of the people think that this move by China will lead to the death of the US$ and/or the death of US Treasuries?

Just Curious.

By the way, in case anyone was wondering about the snapback in treasuries and YEN today the above article might be a clue.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Additional Thoughts on the RMB Repeg

I want to clarify something I wrote yesterday.

When I wrote "In the meantime the bands are playing and the trumpets are blowing as if this will solve some problem or other", I meant to say "US Problem". Perhaps it was obvious, perhaps not since I was questioned about it on Silicon Investor.

It will do little to help with the US current account balance, US deficit spending, US Congress spending like drunken fools, a savings deficient US, outsourcing of jobs, or for that matter much of anything else. Attempting to solve the world's trade imbalances with currency moves alone will prove to be futile. At 20-1 wage differentials it is just not possible. The US needs to stop living beyond its means, and it will be sad if the US thinks the job is now done and results will come pouring in as long as China keeps increasing the value of the RMB.

That said, stopping a global protectionist nightmare in and of itself was significant. China took a step closer to floating the RMB and hopefully this will quell the discussion as to whether or not China is a "currency manipulator". It may put some pressure on the US$ but that is by no means assured in the long term. As long as the US is hiking, I believe the US$ is likely to have a decent bid.

Perhaps that is one reason China acted now. If so, China's timing was perfect. Acting now before the FED pauses on a housing bust was a very good move. Indeed, Stephen Roach proclaims An Awesome Move by China.

China’s long-awaited currency adjustment is unambiguously positive for the global economy. Yes, it is a first step -- and a tiny one at that. But it qualifies China as an active participant in the global adjustment process. Up until now, the Chinese were on the outside, looking in, insofar as global rebalancing was concerned. That was a recipe for increased trade frictions and protectionism -- a hugely destabilizing possibility for an unbalanced world. China’s move on the currency front diminishes those risks and could well provide an important kick-start to an increasingly urgent global rebalancing.

I applaud China’s action for three reasons: First and foremost, it derails Washington’s protectionists and the serious threat they posed to geopolitical stability. Admittedly, a 2% revaluation of the renminbi stops well short of the 27.5% adjustment stipulated by the proposed China Currency Act (S. 295) sponsored by US Senators Schumer and Graham.

A second reason why this action is a plus is that a small currency adjustment does little damage to China export competitiveness. China has already taken actions to cool off its overheated property sector, and it does not want to risk overkill by crushing exports.

Thirdly, China’s new currency policy is a much more stable arrangement for the world financial system. From the Chinese perspective, it will help relieve the tensions that have been building from failed sterilization tactics -- the inability of China to issue enough domestic debt to offset the massive purchases of US Treasuries required by the now-abandoned dollar peg. This was leading to excess money and credit creation -- underscoring the mounting risks of inflation and/or asset bubbles.

Roach concludes:
Let’s give credit where credit is due -- always a hard thing for the world when it comes to China. My advice is to look at what now lies ahead: Do not focus on the 21 July action as the end, in and of itself. While this first move was small and belated, China’s currency adjustment is emblematic of an endgame that could be a linchpin to long overdue global rebalancing. This is awesome news for an all-too-precarious world.

The logical conclusion is that one has to tip the hat to China for when they did it, how they did it, and with how little the initial impact was. China acted with class, unlike some counterparts here in the US.

Will this pressure interest rates in the US? Treasury bears and US$ bears sure think so. They came out of the woodwork to celebrate the demise of US treasuries and the US$.

The initial response was mild: 10 basis points on the 5-yr, 10-yr, and 30-yr notes. Significant but hardly a panic collapse. One day after the event, at least as I am currently typing, treasuries have gained half of that back. The Yen moved about 2.5% on the news but I see it has given back .8% of that. The US$ index is also up about .8% at the time of this writing as well. At least as of now, we have not seen any significant follow thru in relation to what everyone seems to be expecting.

That said one day does not prove much. Is this a profit-taking lull before the storm? Possibly, but if China moves slow enough, perhaps there is no storm. Indeed, perhaps we have already seen the bulk of the reaction with a near 50 basis point jump in the 10-yr note from Bill Gross's capitulation to the spike on the RMB announcement. If that is indeed the case, treasury bears shorting here after this significant move in rates over the past month or so just might be setting themselves up once again to have their heads handed to them.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Inflationists Respond

First let me thank those responding to "the deflation debate".
Robert Blumen wrote an article entitled End Game: Hyperinflation on the Mises Blog on July 9th, and David Petch who wrote Diatribes of a Deflationist........Why They Are Wrong on July 13th. I was hoping for a reply from Puplava but if one was made I did not see it.

Without addressing my blogs specifically, Mr. Blumen has this to say:

The most obvious error in many deflationist writings is to point to the large amount of debt and stop there. All of us agree that the debt levels are unsustainable, but there are two ways of getting rid of debt: default or inflation. A cascading chain of cross-defaults would be the deflation outcome, but this is by no means assured. Historically there have been far more hyperinflations than deflations. Debt can be inflated away.

I am not sure who Blumen is referring to but I laid out a concise multi-point discussion that included the debt overhang but certainly did not stop there. Furthermore I agree that debt "can" be inflated away and even stated how: The FED prints money like mad and Congress gives money away at the expense of creditors to the benefit of debtors..

Blumen goes on to say: Another deflationist argument is that wage competition from China is deflationary, and that inflation cannot occur in the US as long as there is wage competition.

Again that is not my position. I did not say inflation can not occur as long as there is wage competition. However, I most assuredly did stress that wage competition does indeed make it much harder for inflation to take hold. There is a big difference in those statements and it is much easier to attack a straw man that does not exist.

Blumen also writes: Another similar argument is that price increases cannot occur in the US for goods manufactured in China. China will always offer these goods at lower prices than they can be produced in the US, thus causing "deflation". This is also wrong for the same reasons cited above concerning nominal and real prices.

I guess it would be helpful to see some direct quotes from some articles about who is saying what. I sure did not say that. Who did? That said, given 20-1 wage differentials and the outsourcing cycle not complete, there is indeed wage pressures and those wage pressures are indeed deflationary. Again that does not mean price increases can not occur but wage differentials can and have made up for huge increases in commodity prices.

The Blumen article quotes Faber's position on the US$ and gold.
The question here is, what would the dollar sell off against, and what would investors perceive as a safe haven in such a situation? The Euro? Not very likely! Asian currencies? Possibly, but if China were to weaken simultaneously with the U.S. economy it's unlikely that Asian currencies would be viewed as a safe haven. I suppose that in a crisis of confidence arising from an economic or financial problem in the United States of a scale that would lead the Fed to print money in massive quantities, only gold, silver, and platinum would be regarded as truly safe currencies notwithstanding their current weakness.

Not sure about platinum but otherwise I mostly agree. I do not view that as being in conflict with my views on deflation at all. If the US$ does not drop against Asian currencies, the Euro or the British pound, then where is the inflation in the price of finished goods? Non-existent perhaps? Declining perhaps? Does a price rise in gold affect the average consumer? How?

I guess my summation is that Robert Blumen more or less attacked a straw man that does not really exist without really putting together a comprehensive view of how it all fits together. In affect it did NOT address the seven points listed at the end of The deflation debate heats up. Yes, there are scenarios that may address each point individually but the article is lacking a concrete explanation of how the inflationist argument all ties together. There was also no explanation offered as to why or how soaring gold affects consumer prices.

As best as I can tell there is near universal opinion about a housing bubble and subsequent bust, yet no one has yet addressed all of the associated happenings when that event occurs (eg. loss of jobs, falling wages, rising defaults, lower demand for goods, over capacity, the debt bubble, etc, etc, etc) other than "The FED will print its way out of it". Remember, Japan tried and that and it did not work for them. Is the FED truly all powerful to the point of being able to defeat the business cycle? If the FED is, why have we ever had a recession?

OK Mish next Case.
In Diatribes of a Deflationist, David Petch takes my rebuttal of Puplava point by point and addresses each one. This time I am properly quoted. Thanks David! Let's take a look.

David Petch:
1) The first point Shedlock states is oil is deflationary. Last week, I posted an article titled "Peak Oil and What it Means to You" and the take home message is that competition for resources is going to happen, first economically, followed by military intervention as this century rolls out. I can not remember a time in the 36 years of my life on the planet when oil was deflationary.

The oil shortages of the 70's were politically inspired. The inflationary trend at the peak saw housing prices decline 50% of the gain, yet they remained well above the low prices of the 70's. My parents bought their second house in 1972 for $22,000. By 1980 it was approximately $55,000.

The current shortages in oil are a geological phenomenon, not a politically inspired problem. As everyone is well aware, currency inflation is occurring daily and now a coming shortage in oil will create commodity inflation. Companies will only be able to absorb so much of the cost before it inevitably is passed on to the consumer.

Mish Replies:
There are many mistakes in this logic.
1) It assumes demand for goods will stay constant as prices rise
2) It assumes there is not a switch to or coal or uranium or other cheaper energy sources.
3) It assumes renewable energy sources are not discovered.
4) It assumes consumer discretionary spending in other areas is not drastically reduced in response to rising fuel prices
5) It assumes companies can raise prices and consumers will pay up
6) It assumes the world economy will not slow enough to negate the affect of China's increasing energy demands

That's a lot of assumptions. Points 2 and 3 are long term issues not really suitable for near term discussion but may be important at a later date. Points 1, 4, 5, and 6 were not addressed. Yes oil is in short supply, yes I believe in the concept of "peak oil", but not addresses is the fact that the world is likely headed into a recession and that may negate most or all of that increased demand for quite some time.

Furthermore, rising oil is only inflationary when prices are passed on and wages are raised so that other discretionary spending is not reduced to make up for increased oil prices. I see neither happening right now.

In fact, I see the opposite. This may be hard for inflationists to swallow but here it is in black and white in an article by The Independent.

Factories cut the prices they charge their customers last month despite a record surge in raw materials costs, putting their profit margins under pressure and clearing the way for a cut in interest rates next month.

Official figures published yesterday showed that manufacturers' input costs rose at the fastest pace in June for almost two decades.

Jonathan Loynes, the chief UK economist at Capital Economics, said: "This is good news for high-street inflation, but not for profits. Producers are having to absorb the bulk of the ongoing rise in costs rather than passing it along the supply chain."

Hmmm oil has gone from $25 to $60 and factories are cutting prices. How about that! That is not inflationary in my book. Seems like demand has fallen off the cliff in the UK, and it all started with a slowdown in housing. I have said this before and will say it again: The UK is leading the US in this cycle by 6 months to a year. Expect the same action in the US within a year.

David Petch:
2) Even though the current economy is a credit bubble, the creation of money automatically creates inflation as it feeds into the economy through debt. I am not an accounting type, but I am sure their exists neat little schemes for FED printed money to pick up struggling companies or aid in transactions. Oil production is not increasing and monetary expansion is occurring, therefore prices will rise due to shortfalls, plain and simple. Factor in peak oil which is commodity inflation and the inflationary pressures build even higher.

Assume the automobile sector and housing sectors are commodities. There has been overproduction during both these cycles and when a peak is hit, prices will stabilize before plummeting. More supply than demand dictates commodity deflation will occur (housing and automobile sector). Notice how I am separating the terms of monetary inflation from commodity inflation or deflation.

Mish Reply:
You see asset prices being hit in both autos and houses. Good, so do I. You also see over-capacity. Great. That is a key deflationary argument. Somehow the debate turns back to oil and my response is as above. Peak oil does not equate to unending demand and is no guarantee of either price inflation or monetary inflation with rising oil as just proven by the UK. The point being that commodity inflation, not passed along does not result in price inflation (throwing out the term price inflation in addition to the terms monetary inflation, and commodity inflation). That in fact is where the rubber meets the road. If demand falls sufficiently enough, or production(oversupply) rises fast enough, there will not be price inflation (which is what matters to the consumer and to interest rates as well). We are currently seeing oversupply in autos in spite of commodity prices are we not? Are we not seeing price cuts and mammoth rebates as well. Pray tell, exactly what prices will be rising on finished products if we have a housing bust and an auto bust? If rising oil and copper and steel prices (steel now unwinding) did not cause the prices of cars to rise, exactly what will? Please answer that! As for the credit bubble automatically causing inflation (while the bubble is inflating), once again we agree (the affect is clearly seen in housing). But please look ahead, the busting of that bubble will automatically unwind the affects of that inflation, in other words reverse it. Again I point to action in the UK right now as a good example. Oddly enough you even understand the basic premise (deflating asset bubbles and car price and housing prices) yet fail to come to the proper conclusion about rising oil causing rising prices, and you ignore the demand side issues of oil as well.

David Petch:
3) Currently the USD index appears to have completed and elongated flat (wave C longer than wave A or B) and this pattern pretty much happens in triangle formations only. A triangle has 5 legs and the first one for the USD lasted 6 1/2 months. This translates into a USD remaining range bound between 80.5 and current levels for another 24-28 months before falling through 80. At this point people will buy gold and silver bullion. They will line up like there is no tomorrow.

Mish:
So what? Other than "lining up like no tomorrow" to buy gold and silver I basically agree. You seem to agree with Faber and so do I. I will repeat my reply I made earlier to Robert Blumen: Exactly how does this affect inflation in the price of finished goods? Does a price rise in gold affect the average consumer? How? As for a falling US$, Faber seems to disagree but I think it is likely. Thus we agree again. The inflationary affects of a falling US$ will be resolved by falling demand for goods associate with a housing bust. Using your own words from above "overcapacity".

David Petch:
4) Housing prices will decline as per a commodity deflation. ... Just because prices of one sector of the economy declines does not mean that everything else does. As an example, the Nasdaq and major markets in 2000 had severe declines, wiping out 5 trillion dollars of equity, yet oil went from $10/barrel to the recent high of $62/barrel during the correction and since then.

Mish:
For the sake of clarity, Petch's respons above was in reply to my question to Puplava... [Jim Puplava writes "The government takes over GSEs owning most American mortgages." Shedlock responds "Even assuming this happens, how does that lead to hyperinflation?".....] Petch's answer above seems to be in agreement that Puplava's statement is nonsense as related to causing hyperinflation. Otherwise, trying to tie oil and the Naz together makes no sense at all.

David Petch:
5) By forcing individuals to buy zero coupon bonds, the government has a larger pool of capital to reduce the effects of their inflation agenda. For example, if the government can forcibly collect $500 billion/year from pension funds, then it can inflate at $500 billion per year without any net addition of capital to the system. This directly does not cause hyperinflation, but rather contains it.

Mish: For the sake of clarity the above was Petch's response to the question I posed as follows... [Jim Puplava writes "A national retirement security act is passed, forcing private pensions to buy long-dated zero-coupon government bonds that will be inflated away. The reason given will be for plan protection against bear markets." Shedlock responds "Assume such a bill is passed -- I seriously doubt it, but for the sake of argument, I will assume it happens. Pray tell, exactly how is that hyperinflationary? How and to what extent would it increase the money supply or cause prices to rise?"] It seems Petch has thought out the answer better than I could at the time. I accept that answer. Puplava's hyperinflationary point just does not make any sense.

So....
As best as I can tell Petch agrees that two of Puplava's hyperinflationary points are silly, all three of us (Petch, Blumen, Mish) as well as Faber and Puplava ultimately see a bright future for gold as a result of the FED trying to stimulate the economy in a housing bust. Even so, I fail to see (and no one even tried to explain) how rising gold prices causes other consumer prices to rise. Unless that would happen, rising gold prices are more or less meaningless except to those holding gold. As best as I can tell then, Petch's hyperinflation rests solidly on oil (or perhaps other commodities), even though we have not see much pass thru yet, especially in Autos. For multiple reasons the assumption of forever rising oil prices is in and of itself on shaky ground (near term anyway), in face of a consumer led or housing led recession.

More to the point, I fail to see how either Petch or Blumen or Puplava have addressed the heart of this debate. I will repeat it again one more time.

Here is the nut hyperinflationists need to crack:

1. Falling home prices
2. Falling wages
3. Stagnant employment or rising unemployment
4. Slowing world economy
5. No incentive for the FED to bail out consumers at the expense of banks
6. The K-Cycle is not likely to be defeated by throwing more money at the problem.
7. At some point lenders refuse to lend or borrowers stop borrowing. That time will be at hand when housing plunges. Look at current events in the UK as a prelude for what will happen here.

What I see is both Petch and Blumen (who have responded and Puplava who has not) failing to address the above scenario in a logical manner, consistent with a housing bust (obviously accompanied by huge job losses in the housing sector) and additional outsourcing of jobs to China and India to cut costs, accompanied by falling demand for goods. Since we all seem to agree on a housing bust, I am still searching for a logical scenario that causes "price inflation" in the face of that. That is where the rubber meets the road. Not only do think we see price deflation (certainly in assets like stocks and houses), but I also believe the destruction of credit (and money) in the next down cycle will be enormous. Rising oil prices is NOT the "hyperinflation answer" for many reasons in theory and as the UK has proven in actual practice. Furthermore, if the recession is deep enough (as I suspect it will be) oil prices are likely to fall, peak oil or not.

For the record, I am convinced that Petch will be eventually correct and that oil prices are going to rise over time, to substantial new highs from these levels near 60. That timeline is a long one however, and near term I expect flattening or declines as the world wide recession kicks off.

There is a nice chart in Petch's article showing inflation headed up for something like forever and I would be remiss if I did not address that. Here goes. Be very, very careful about extending trends to perpetuity. They don't get there. I offer the Naz bubble as proof. Faber warns about that in his excellent book "Tomorrow's Gold". It should be on everyone's reading list. I also recommend "The Dollar Crisis" by Richard Duncan. My thinking has been heavily influenced by both of those authors.

Finally, let me state the inflationist scenarios as best as I can since no one else seems willing to take it on.

Here are two scenarios that will work:
Scenario A:
A1)Increasing demand for commodities from China.
A2)Housing prices stay strong and economic activity picks up worldwide.
A3)US wages rise
A4)Rents rise
A5)Demand for goods in the US stays strong
A6)Demand for goods in Europe picks up
A7)Demand for goods in China picks up

It may not take all of those but it would take a lot of them to be consistant with sustained inflation.

Scenario B:
B1)Increasing demand for commodities from China in the face of a US housing bust
B2)Consumers keep spending money and banks keep lending even as asset prices fall
B3)Should consumers stop spending in the face of job losses associated with the housing bust, the FED goes on a mad printing spree.
B4)Since the FED can print but not force the consumer horse to drink (increase borrowing), a "helicopter drop" is issued (whereby Congress passes laws that literally gives money away to consumers)
B5)The "helicopter drop" is done in the US only and other countries refuse to finance it. (If everyone did it the US$ would not drop).
B6)Banks and other creditors have no say in this and are destroyed along with the FED in the hyperinflation that takes over.
B7)The consumer is bailed out at the expense of big creditors like Citycorp, American Express, Visa, MasterCard, etc.
B8)The business cycle is defeated. There will never be a recession again.
B9) Consumers never need to save again but are bailed out by rising asset prices.

Again it may not take all of those but it would take the crucial ones: The FED and Congress acting together to bail out consumers at the expense of creditors. It would probably have to be a US related thing only to force the dollar to get smashed vs. other fiat currencies.

That is what I am looking for: A logical scenario that addresses the full implications of a housing bust, or some sort of scenario that addresses the full implications of a FED that voluntarily produces hyper-inflation. Petch tries to address the issue with "asset deflation" vs. "monetary deflation" on a scenario mainly tied to oil, but that scenario ignores falling demand issues as well as the possibility (likelihood?) of oil prices falling. Even IF oil prices do not fall, evidence shows lack of pricing power on finished goods.

Should someone think B2 is likely I disagree and point to the UK (now) and Japan for the past 18 years. In addition, it is logical to assume banks will tighten standards to prevent defaults or consumers will pull in their horns or most likely both in the face of falling home prices.

Finally, I do not think hyperinflation was ever voluntarily and purposely attempted (to bail out consumers) but that seems to be what is suggested by all these "helicopter drop" scenarios. Threat yes, but in practice no. Thus I find both of the above scenarios to be absurd. The FED and the powers that be will not voluntarily destroy themselves. Will they fight deflation? Yes. Will they fight deflation to the point of destroying themselves? No. That would not only require printing presses but action from Congress as well. The scenario is simply not consistent with a Congress that passed "bankruptcy reform" to keep consumers indebted forever.

Bottom line: I expect to see a prolonged period (5-12 years looking forward) where deflation is predominate, interspersed by temporary stock market rallies with long term interest rates slowly sinking to 2.5% or so.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Thoughts on the RMB Repeg

Today, July 21, 2005 China repegged the RMB to a basket of currencies.

Just yesterday I wrote China Calls US's Bluff

Many were betting on a repeg by Autumn 2004, then January 2005. January became June as a trader I generally trust "guaranteed" me it would happen. oops. Then the bets shifted to August. I would say the already poor odds of a RMB repeg by August have likely gone out the window. Eventually China will float, but it will be at a time of their choosing not ours, and when they do, we might not care for the result either.

Note: if enough hot money flees China soon enough possibly we see some movement, I just doubt this is the time. At some point I will likely be wrong but it sure seems to me the smart money has been betting against it.

Well one day later we did see "some movement" and as I suggested, I would eventually be wrong. I just never thought it would be one day later.

There are a lot of articles out there about this so let's review one straight from the horse's mouth. Here is the official Public Announcement of the People's Bank of China on Reforming the RMB Exchange Rate Regime

July 21, 2005

With a view to establish and improve the socialist market economic system in China, enable the market to fully play its role in resource allocation as well as to put in place and further strengthen the managed floating exchange rate regime based on market supply and demand, the People's Bank of China, with authorization of the State Council, is hereby making the following announcements regarding reforming the RMB exchange rate regime:

1. Starting from July 21, 2005, China will reform the exchange rate regime by moving into a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. RMB will no longer be pegged to the US dollar and the RMB exchange rate regime will be improved with greater flexibility.

2. The People's Bank of China will announce the closing price of a foreign currency such as the US dollar traded against the RMB in the inter-bank foreign exchange market after the closing of the market on each working day, and will make it the central parity for the trading against the RMB on the following working day.

3. The exchange rate of the US dollar against the RMB will be adjusted to 8.11 yuan per US dollar at the time of 19:00 hours of July 21, 2005. The foreign exchange designated banks may since adjust quotations of foreign currencies to their customers.

4. The daily trading price of the US dollar against the RMB in the inter-bank foreign exchange market will continue to be allowed to float within a band of +-0.3 percent around the central parity published by the People's Bank of China, while the trading prices of the non-US dollar currencies against the RMB will be allowed to move within a certain band announced by the People's Bank of China.

The People's Bank of China will make adjustment of the RMB exchange rate band when necessary according to market development as well as the economic and financial situation. The RMB exchange rate will be more flexible based on market condition with reference to a basket of currencies. The People's Bank of China is responsible for maintaining the RMB exchange rate basically stable at an adaptive and equilibrium level, so as to promote the basic equilibrium of the balance of payments and safeguard macroeconomic and financial stability.

OK So China move to a "managed floating exchange rate regime" against a "basket of currencies", with an initial adjustment of 2% against the US$ that is "allowed to float within a band of +-0.3 percent".

No one knows the precise makeup of the basket, there is no timetable for further revisions so the initial 2% adjustment is more symbolic than anything.

Kathy Lien on DailyFX offers An In Depth Look at What the Chinese Revaluation Means For The Markets:

China will move to a managed float against a basket of currencies

This is the real story. China is planning to move to a managed float against a basket of currencies. Not many details have been disclosed on this front but the People’s Bank of China has written the following on their website: “the trading prices of the non-US dollar currencies against the RMB will be allowed to move within a certain band” - which will be announced later by the PBoC. We suspect that China will take an approach similar to that of Singapore, which is to float their currency against a basket of other currencies within a tight trading band while not disclosing the exact percentage make-up of the basket to prevent speculators from attempting to manipulate their currency. Given that China exports a large percentage of its goods to not only the US, but also the European Union and Japan, the basket would naturally have to include Euros as well as Japanese Yen. This in of itself could be very positive for both of those currencies. Also, if you recall, those currencies were indeed apart of the currencies that China’s internal “interbank” system was trading in May.

Kathy Lien also offered this commentary on treasuries:

Treasuries - China’s move has ramifications for all of the financial markets. The most significant of which will probably be in US treasuries. As the world’s second largest holder of US treasuries, China’s revaluation and move to a basket float significantly reduces their need for US treasuries and could potentially take away a big buyer from the market. If this is the case, it will cause bond prices to slide and long-term yields to rally, which could offset some of the additional pressure on the Federal Reserve to continue raising rates. If China even begins to dump US treasuries, we could see the “yield curve conundrum” begin to fix itself.

Treasuries are interesting because I was just debating Mark Hulbert of MarketWatch on whether or not there was a A New Conundrum in Treasuries.

Mr. Hulbert was in a conundrum because "The bond market has fallen markedly over the past month even while bond investors appear to have become less concerned about inflation."

I thought there was no conundrum and listed the following three reasons:
1) In the wake of capitulation by Bill Gross and Stephen Roach (the newest treasury bulls), some sort of snapback should be expected. I went neutral on treasuries shortly after Gross's capitulation.

2) Perhaps the treasury market is looking forward to the next FED pause. I think at least a short term sell off is likely when the FED pauses and then again when the FED first cuts. Mish did you say cut? Yes I said cut.

3) Corporate bond investors have gotten insanely greedy lately. Investors are chasing any little bit of extra yield they can find. As a topping process in this greed, there is an increased risk preference for junk bonds vs. treasuries. Even the riskiest of junk has been receiving very healthy bids. Eventually this insanity in junk will unwind and there will be a mad rush (a re-pricing if you prefer that term) back into treasuries and away from risk.

Hmmm...
Looks like we have a 4th reason that did not occur to me yesterday.
4) China to repeg to a basket of currencies.

Mark, If you happen to be reading this, I am 100% sure your conundrum is now resolved. I would guess that although all four items played a part, the order of significance is 1,4,2,3 perhaps 4,1,2,3 but I have little doubt that the capitulation of Gross kicked it off. Did someone know about the repeg? Nah, can't be. That never happens, right Mark?

Market futures sure were wild today with a huge gap up pre-market (any S&P stops were likely hit) followed by a huge gap an crap decline, followed by a mid-day rally, and a tank job into the close. Is that enough excitement for everyone? Perhaps today is the start of a downside reversal given that stops above have all been cleared out.

Gold was acting weird yesterday, nothing that I can really point to in particular, but just before the gold close I thought gold was acting stronger than I expected so I bought deep ITM DEC calls. We are very close to the seasonal buying period (normally I get in at the end of July). This was a "just in case" type of play (and to be honest nowhere near a full position). A couple of people on the Motley Fool and Silicon Investor bought in as well. Let's see if this is a head fake or the real deal this time.

The #1 big question now is: "What is priced into treasuries"?
Housing is stalling in a number of localities, inventories are building, but most important people buying 1-yr, 2-yr, or 3-yr adjustable mortgages or LIBOR based loans near the interest rates lows are going to start feeling some heat. If treasuries continue to sell off, look for pressure not only on housing, but financial sector and retail sector stocks as well.

Note that although treasuries fell hard across the board today, the 5-yr, 10-yr and 30-yr all fell about the same amount. There has been no significant widening of the yield curve, and if anything the spreads have tightened further over the last couple of weeks. The five and dime spread is a mere 20 basis points and the ten thirty spread is under 22 basis points. That is not a lot of difference for what seems to be a lot of extra risk. If Greenspan hikes twice more, I think the yield curve inverts somewhere.

Again, this SHOULD not be good for equities, but there is still amazing amounts of liquidity sloshing around (and there likely will be until housing breaks). Guess we will see.

The #2 big question now is: "Did this placate the US Congress, and if so for how long?"
On the surface, this repeg did nothing. It is symbolic only. 2% is peanuts when Congress thinks the RMB is 30-40% undervalued.
I have to tip my hand to China. This was a smooth operation designed to give as little as possible, forcing out as much hot money as it could in the interim. I proposed weeks ago for China to repeg 1% higher when they do it. Perhaps that would have been too big a slap in the face to the US.

Elroy on Silicon Investor writes "It’s the big Grand Opening of absolutely nothing - complete with spotlights and a band." I happen to agree. Nonetheless, it likely did buy China time on silly tariff legislation. In that end, it was not useless. I offer the following as proof that China may have placated the US: China's move is good first 'baby' step Schumer says.

A top congressional critic of China's trade policies said China's announcement that it would let the yuan float a bit was a "good first step, albeit a baby step." Sen. Charles Schumer, D-N.Y., said the move "is smaller than we had hoped, but to paraphrase the Chinese philosophers, a trip of a thousand miles can well begin with the first baby step." Schumer has sponsored legislation that would impose significant tariffs on Chinese imports unless it allows its currency to float freely on global markets.

The #3 big question is: "How much hot money left China, and if it did, how fast will it return?"
I was fortunate enough to have a chance to talk to Paul Kasriel at the Northern Trust today. We were discussing today's events. Neither off us knows if hot money was forced out of China before this action. I suggest that China forced out as much as it thought that it could. But quite frankly, other than China, who could possibly know? Looking ahead, how fast will hot money flow back into China? Again, no one knows. The faster it does, however the more inflationary pressures will build in China. If China reacts by raising interest rates, that just might magnify China's problem.

Short term it seems we may have dodged a protectionist bullet. We will find out soon enough.
Long term, a 2% RMB change, a 5% change, or even a 20% change is not going to do the US one bit of good towards rebuilding of a manufacturing base in the US. In fact, I doubt it has any affect on even stemming the tide of outsourcing, not with a 20-1 wage differential. Not only will it not stop outsourcing or improve exports it will probably do little to address the US Current Account Balance. Long term, it bought China some time so later on down the road China will be prepared to float the RMB at a time of its choosing not ours.

In the meantime the bands are playing and the trumpets are blowing as if this will solve some problem or other. Rest assured this solves nothing other than perhaps preventing stupid protectionist tariffs by the US Congress.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Hyperinflation? This is Hyperinflation.

The Australian reports that Zimbabwe's currency is not worth the paper it's printed on.

Let's take a look.

When Roy Bennett, a former opposition MP, finished his jail sentence this month for shoving one of Mr Mugabe's ministers, he received the release gratuity of $Z6 to help him "re-enter society".

It showed how sublimely out of touch the Government is. A box of matches costs $Z1000.

Inflation hit 164 per cent last month. Economists predict it will double in five months, and again three months after that. This time last year, pound stg. 1 fetched $Z8500 on the black market, increasingly the only real exchange. Yesterday it fetched $Z54,000.

The $Z20,000 bill is the currency's highest denomination and its most common unit. It is not a banknote, however, but a bearer cheque - and most carry a 2004 expiry date.

The Government has cut fuel prices for buses and minibuses to $Z6000 a litre, so minibus drivers fill up, drive around the corner and sell the fuel for up to $Z120,000 a litre, then rejoin the queue.

That is hyperinflation. Anyone that thinks the situation in the US will remotely look like this any time soon is nuts.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

A New Conundrum in Treasuries?

Mark Hulbert on MarketWatch is reporting a new conundrum in US treasuries.

I have another conundrum to add to the one that Federal Reserve Chairman Alan Greenspan complained about six months ago.

Greenspan, of course, was referring to the puzzling behavior of long-term interest rates. Even though the Fed has been steadily raising short-term rates, long-term rates have been falling -- unexpectedly flattening the yield curve.

The additional conundrum I have in mind has materialized more recently. The bond market has fallen markedly over the past month even while bond investors appear to have become less concerned about inflation.

It's usually the other way around, of course. Bonds more typically rally in the face of a lessening of inflationary fears, on the theory that the Fed will thereby feel less pressure to raise interest rates.

Marvin Appel, editor of the Systems & Forecasts newsletter, pointed out this unusual behavior in his telephone hotline Monday night: "Long term bond yields continue to climb, supposedly reflecting fears that Federal Reserve Chairman Alan Greenspan will testify later this week as to ongoing strength in the economy."

Personally I think there are three logical explanations for this behavior and there is no "new conundrum".

1) In the wake of capitulation by Bill Gross and Stephen Roach (the newest treasury bulls), some sort of snapback should be expected. I went neutral on treasuries shortly after Gross's capitulation.

2) Perhaps the treasury market is looking forward to the next FED pause. I think at least a short term selloff is likely when the FED pauses and then again when the FED first cuts. Mish did you say cut? Yes I said cut.

3) Corporate bond investors have gotten insanely greedy lately. Investors are chasing any little bit of extra yield they can find. As a topping process in this greed, there is an increased risk preference for junk bonds vs. treasuries. Even the riskiest of junk has been receiving very healthy bids. Eventually this insanity in junk will unwind and there will be a mad rush (a re-pricing if you prefer that term) back into treasuries and away from risk.

There you have it: Three logical explanations for the newest treasury conundrum. I think it is some combination of the three. Simply put, there is no conundrum.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

China Calls US's Bluff

The Chinese Central Bank called the US Tariff/currency manipulator bluff today with this message
China to keep RMB exchange rate basically stable.

China's central bank said Tuesday it will continue to keep the exchange rate of Renminbi, China's currency, basically stable at a reasonable and balanced level in the second half of this year.

In a press release issued after a meeting by heads of the bank and its provincial branches, the bank said it is one of its major tasks in the six months to deepen the reform of its foreign exchange administrative system, and push forward the reform of RMB exchange rate mechanism and keep the RMB exchange rate basically stable at a reasonable and balanced level.

Many were betting on a repeg by Autumn 2004, then January 2005. January became June as a trader I generally trust "guaranteed" me it would happen. oops. Then the bets shifted to August. I would say the already poor odds of a RMB repeg by August have likely gone out the window. Eventually China will float, but it will be at a time of their choosing not ours, and when they do, we might not care for the result either.

Note: if enough hot money flees China soon enough possibly we see some movement, I just doubt this is the time. At some point I will likely be wrong but it sure seems to me the smart money has been betting against it.

In the meantime that money sitting in China has to be practically burning a hole in someone's pocket. US 90 day interest rates are close to 3.25% now. That money has been sitting there doing nothing rather than collecting interest in the US. I see no reason why China can not outlast the US on this issue.

By the way, where are all the US dollar bears warning China to repeg before it's too late?

Here is the bottom line:
If China holds pat, we may soon find out just how stupid the US Congress is.
If the US imposes 27.5% tariffs, they will prove to be even dumber than I thought.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

A Real Morale Booster

Reuters is reporting HP to slash workforce by about 10 pct

"They've gotten themselves in fighting shape here," said Caris & Co. analyst Mark Stahlman, adding that it dispels uncertainty, which had been frustrating for some in HP's engineering culture. "I think this is going to give a big boost to morale internally," he said.

Enquiring minds might be asking some of the following questions:

1. When was the last time firing 14,500 people boosted morale?
2. Would firing 20,000 have boosted morale even more?
3. Is there a "Laffer Curve" on firing people to boost morale?

Perhaps HP was jealous of the big morale boost at IBM and Sanyo.
IBM is cutting about 14,000 jobs, mainly in Europe.
Sanyo announced layoffs of 14,000 jobs earlier this month.
Is 14,000 the magic number?

Reports like these are bound to be good news good news for Walmart.

1. There are another 14,500 potential Walmart Greeters searching for jobs.
2. This will keep up the price pressures on Walmart wages.
3. Some of those fired engineers will start shopping at Walmart instead of The Sharper Image.

Seriously, mergers outsourcing and other consolidations are costing the US hundreds of thousands of jobs. Massive amounts of announced layoffs in the banking and telecom industries will start kicking in the second half of the year. Eventually this will spill over and affect housing just as it has in the UK and Australia.

The question I am pondering right now is this:
How much more "morale boosting" can this economy take?

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Renovators' Nightmare

Conventional wisdom says that trade jobs related to housing will remain strong even if new home construction takes a tumble. I guess the theory is that people will have to maintain their houses and will be putting more into them as opposed to buying new houses. These things are hard to debate with the "housing will never die" crowd so sometimes you just have to wait for a practical example. I just found one.

The Sydney Morning Herald is reporting a renovators' nightmare for builders.

Sydney's infatuation with home improvements has abruptly ended, as evidence grows that the end of the housing boom is hitting the city's economy.

The value of home renovations in NSW has plunged $120 million in just three months, or more than 20 per cent - the largest fall in dollar terms since the Bureau of Statistics began collecting records in 1974.

The number of home building starts in the state also fell, as did the total value of building work in the March quarter.

Architects, seen as bellwethers for the building industry and the broader economy, said yesterday that their workloads had held up nationally but fallen by a third in Sydney since the peak of the boom two years ago.

We have already seen consumer spending and home sales drop like a rock in both the UK and Australia. One argument currently floating around in the US is that we aren't making any more land. The Last time I checked they were not making land in London any more either. Japan has not made any land recently but that did not stop prices from falling for 18 consecutive years.

The UK is just about finished year one of a housing bust and Australia is well into year two. Already UK retailers are clamoring for lower interest rates to prop up consumer spending. The first of probably many rates cuts in the UK is likely in August. I doubt it will do any good. Consumers are just plain tapped out and job losses are mounting.

The UK "Consumer Spending Express Train" has left the station. It is now heading South. It may be years before it heads back North. Look for Sydney to lead. I suspect we will soon be hearing about "Renovators' Nightmares" in the UK. A liquidity trap is coming your way soon.

Meanwhile, back in the US, consumers merrily go about their business buying homes sight unseen. Check out this article in Newsweek Business.

"In the last year Stocker has also bought rentals in Alabama and Florida; he hopes to buy at least 10 altogether. 'Next year I plan to buy a motorcycle and take a tour of my properties,' he says, since he's never seen any of them."

These Johnny-Come-Latelies accumulating condos and houses sight unseen will soon be in for a rude awakening. Professional investors are for the most part gone but amateurs are still bidding up properties even with inventories of unsold homes skyrocketing in Boston, California, Las Vegas and other places. 80% of the condos in Florida are now being sold to "investors". The writing's on the wall if anyone would bother to stop and read it.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/