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Posts Tagged ‘deflation’

Dollar Devaluation Is a Dangerous Game

Posted by Larry Doyle on October 8th, 2009 9:24 AM |

Can we ‘devalue’ our way back to our days of economic ‘wine and roses?’

Many debt-laden countries throughout economic history have chosen to implicitly or explicitly pursue a devaluation of their currency as a means of improving their economies. Are the ‘wizards in Washington’ taking this approach? Aside from a few perfunctory comments in defense of the greenback, Washington has been largely silent on the topic of the declining value of the dollar. Many believe Washington very much favors a weaker currency as a means of supporting our economy. I believe this of Washington, as well. Let’s navigate.

Going back to the G20 in London last Spring, the Obama administration has attempted to curry political favor with emerging economies, especially the BRIC nations, by ceding dollar sovereigncy as the preeminent international reserve currency in return for support of global economic stimulus programs. Why does Washington believe a weak currency serves our economic interests? A weak currency generates and supports the following:

1. Promotes inflation as imports decline. Washington would like some inflation, given the massive deflationary pressures presented by falling wages and declines in the value of commercial and residential real estate.

2. Promotes exports for corporations with a multi-national presence.

3. Supports labor by making it more attractive for companies to keep jobs here as opposed to opening factories or sending work overseas.

So, in light of our current economic crisis, why wouldn’t we want a substantially cheaper dollar to maximize these benefits?

Recall that economists always need to keep certain variables static in order to study the impact of a change in another variable or multiple variables. This approach, known as ‘ceteris paribus,’ is not quite as easy as some may think. Why? Variables are NEVER static, or ‘ceteris is NEVER paribus.’ (more…)

U.S. Markets Play “Follow the Leader”

Posted by Larry Doyle on October 7th, 2009 9:40 AM |

Yesterday’s rise in rates by the Australian central bank is a bellweather sign of the global shift in the balance of economic power. While the rise in rates by the Aussies is the first central bank move, it certainly will not be the last. Why did the Aussies raise rates and what does it mean both in the short term and for the long haul? Let’s navigate.

The Australian economy did not have near the level of debt that burdens the U.S. and Europe and thus they did not need near the amount of monetary stimulus to weather this global recession. Additionally, Australia has benefited from extensive trade in the Asian hemisphere.

The knee jerk reaction in the markets was focused primarily on a selloff in the greenback which supported a move higher in commodities and global equities via the ‘positive carry trade.’ The commodity which garnered the greatest focus was gold, which moved toward $1040/ounce.

What do these moves mean? I see cross currents on the economic landscape, including:

1. The dollar may not necessarily continue to weaken, but given its current weakness it will support those companies which garner a greater degree of sales overseas.

2. A weak dollar is usually affiliated with inflation. I do not think we are in a position to look at prices in terms of one overall index. Why? Given the technical and fundamental factors in our economy, certain price components will likely project increased inflation while others will not.

To be more specific, given the labor situation in our country, I do not see any appreciable increase in wages anytime soon. In fact, I think it is likely wages will trend lower.

Given the glut of supply and vacancies in both the residential and commercial real estate markets, I have a tough time believing these prices will move appreciably higher anytime soon.

Commodities may very well move higher. Why? High five to MC for sharing with me that there is increased dialogue in the international trade community to move oil away from trading in dollars. In fact, that story likely had a big impact in yesterday’s trading. Even if there is not an immediate shift in this market dynamic, the mere fact that it is being discussed will support oil specifically, oil-based products broadly, and other commodities as well.

Given that these commodities are primarily inputs, the prices for the outputs will likely move higher. This development is clearly inflationary.

3. What happens to interest rates here in the United States? While on one hand we have some deflationary forces at work which would keep rates low, we have the tug of other factors pushing them higher. How does it play out? My gut instinct tells me that overall pools of capital will be flowing away from the United States and, as such, people and private corporations will have to pay more to attract capital here in our country. I think those entities which focus the bulk of their economic activity here in the United States will be forced to pay higher rates to attract funding.

4. What about our equity markets and the Fed? While the Fed will want to keep our rates low for an ‘extended period,’ they may not have that luxury. If other nations follow Australia in raising rates, the U.S. may need to withdraw some liquidity sooner rather than later. Kansas City Fed chair Thomas Hoenig made this very assertion yesterday.

What would higher rates mean or even the thought of higher rates mean? Slower growth and a tough road for equities going forward.

Thoughts, comments, questions always appreciated.

LD

Related Sense on Cents Commentary

Dollar Carry Trade Drives Global Equities (September 16, 2009)

Inflation, Deflation, or Stagflation?

Posted by Larry Doyle on June 1st, 2009 11:06 AM |

I am an eternal optimist and, as such, I never want to see people’s spirits waver. I encourage people not to allow the current economy to “deflate” their hopes for better days. By the same token, I am a pragmatist and caution people not to view the recent bounce in our equity markets as reason for an overly “inflated” sense of optimism. In this same spirit, though, we need sufficient optimism along with practical analysis to avoid the perils of “stagflation.” Let me expound.

The debate between analysts touting prospects for inflation versus deflation is ongoing. Those concerned with deflation highlight increasing levels of unemployment pressuring wages, falling asset valuations, and slack consumer demand. Those concerned with inflation point toward the unprecedented levels of liquidity injected into our system via all of the government programs. The inflation hawks maintain the economy merely needs a small spark and inflation will spread in an uncontrollable arson-like fashion.

I actually believe there is a very real chance we get developments from both camps leading to the scourge known as stagflation. How may this play out?

Many respected analysts are promoting the concept of a new “normal” economy. This scenario entails an economy operating with enormous government deficits, an elevated level of unemployment, and little to no shadow banking system (securitization of loans and other assets).

In this new “normal” economy, GDP may only eke out small positive growth given these heightened pressures. Pimco’s Mohamed El-Erian writes of A New Normal:

This reflects a growing realization that some of the recent abrupt changes to markets, households, institutions, and government policies are unlikely to be reversed in the next few years. Global growth will be subdued for a while and unemployment high; a heavy hand of government will be evident in several sectors; the core of the global system will be less cohesive and, with the magnet of the Anglo-Saxon model in retreat, finance will no longer be accorded a preeminent role in post-industrial economies. Moreover, the balance of risk will tilt over time toward higher sovereign risk, growing inflationary expectations and stagflation.

Even as we come out of this recession, our economy will run increased risks of slipping into another recession given the lack of cushion provided by a strong consumer, the burdens of heavy government debts, and inability to easily access credit.

El-Erian adds:

For the next 3–5 years, we expect a world of muted growth, in the context of a continuing shift away from the G-3 and toward the systemically important emerging economies, led by China. It is a world where the public sector overstays as a provider of goods that belong in the private sector. (As one of our speakers put it, we have transitioned from a world where the private sector provided public goods to one where the public sector provides private goods.) It is also a world in which central banks and treasuries will find it difficult to undo smoothly some of the recent emergency steps. This is particularly consequential in countries, such as the U.K. and U.S., where many short-term policy imperatives materially conflict with medium-term ones.

As our global economy transitions to this new “normal,” I believe the likelihood of stagflation is quite high. For those who recall the perils of our economy in the early 1980s, stagflation is not a pretty picture. How does one manage investments and personal finances in an environment of stagflation?

Let’s deal with the component parts. Given sluggish growth, limited credit, and lessened opportunities, it is of paramount importance to cut expenses and minimize debt as much as possible. Servicing debt will be an ongoing challenge and increasingly problematic. Be proactive at this point in time in adjusting your finances to this reality.

Where will the inflation come from and how does one address it? In my opinion, the inflation “train” will arrive sooner than we think. Some of the savviest investors, including Financial Pacific Advisors’ Bob Rodriguez and noted Black Swan author Nassim Nicholas Taleb, are already positioning themselves for it. (The WSJ reports, Black Swan Fund Makes a Big Bet on Inflation).

How can people protect themselves from the inflation monster? Increase exposure to the following:

  – precious metals and commodities

  – critical infrastructure (power plants, agriculture, water, transportation)

  – necessary life items (drugs, medicines, food)

  – stronger and more fiscally prudent foreign markets

Decrease exposure if not get outright short

  – longer maturity (5yr and and longer) Treasury bonds

This stagflation story will have many chapters and I will be writing extensively on it. Please share your thoughts, opinions, and recollections of the early 80s economy so we can all move forward most effectively in navigating the economic landscape.

LD

Goldilocks Economy

Posted by Larry Doyle on May 8th, 2009 1:15 PM |

Will the wizards in Washington be able to recreate the Goldilocks economy, in which we can generate moderate growth with limited inflation and near full employment? Well, that economic dream is still off in the distance, but the Goldilocks analogy is appropriate. How’s that? Much like the cherished tale, the wizards are faced with three choices in virtually every situation: too much, too little, just right.

Fiscal policy
 – too much spending and/or improperly targeted spending will drive interest rates higher via massive deficits and potential hyperinflation.

 – too little spending and/or improperly targeted will not properly stimulate the economy and may lead to a bout of deflation.

 – just the right amount of spending and properly targeted will support the economy and stabilize prices.

Monetary Policy
 – too much gas on this fire will massively grow the money supply and lead to hyperinflation.

 – not enough gas or a slow delivery (the concern in Europe) will not stop the economy from sliding into a deeper recession.

 – just right will lead to support for the economy. However, our wizards must be prescient and know exactly when to turn the gas line down and then off. If this procedure is not executed with precision, our house may go up in the flames of hyperinflation. Many wise and elderly wizards, including none other than Paul Volcker, have this concern.

Regulatory  
 – overly restrictive regulations will inhibit an entrepreneurial spirit and drive business overseas.

 – ineffective, inappropriate, or insufficient regulations will lead to further moral hazards and an economic foundation akin to a pile of sand. Dare I say, our house is suffering from this problem currently.

 – just right would compel new regulators with real teeth to redraft the rules by which we play. Paul Krugman wrote “Stressing The Positive” in yesterday’s New York Time and addressed this topic. Krugman offers:

. . . what worries me most about the way policy is going isn’t any of these things. It’s my sense that the prospects for fundamental financial reform are fading.

Does anyone remember the case of H. Rodgin Cohen, a prominent New York lawyer whom The Times has described as a “Wall Street éminence grise”? He briefly made the news in March when he reportedly withdrew his name after being considered a top pick for deputy Treasury secretary.

Well, earlier this week, Mr. Cohen told an audience that the future of Wall Street won’t be very different from its recent past, declaring, “I am far from convinced there was something inherently wrong with the system.” Hey, that little thing about causing the worst global slump since the Great Depression? Never mind.

Those are frightening words. They suggest that while the Federal Reserve and the Obama administration continue to insist that they’re committed to tighter financial regulation and greater oversight, Wall Street insiders are taking the mildness of bank policy so far as a sign that they’ll soon be able to go back to playing the same games as before.

Uncle Sam’s intervention
 – too much involvement means private enterprise will either not play in our markets or charge a higher price in the form of higher interest rates (this is VERY likely to happen given the disregard for property rights and the validity of contracts).

 – too little and the economy may take another leg down in the form of a triple dip.

 – just right . . . how do we compel Uncle Sam to be a benevolent Old Man and not encroach on the principles of capitalism, free markets, and private enterprise as he tries to push forward with a massive social agenda and enormous spending plans?

The trail on which we are proceeding will be LONG. Will we be able to find that warm home in the woods? Do we have the fortitude and courage to sacrifice as need be or do we have leaders who are blinded by ambition and agendas which will cause us to lose our way?

Bring extra supplies.   

LD

Deflation? Tell That to Colgate and P&G

Posted by Larry Doyle on May 1st, 2009 1:09 PM |

Analysts and economists are pointing toward a near term decline in prices while raising concerns about inflation down the road. Disinflation (a slower pace of inflation) or deflation (an actual decline in prices) are a crushing blow to a company’s bottom line. That said, companies are incentivized to discount prices in order to move inventory. Consumer discretionary items are much more subject to discounted prices than consumer staples.

My better half came home from the supermarket the other day commenting on definite increases in price on a wide array of basic staples. To that end, I am not surprised to read that Colgate and P&G are raising prices. Can price increases in the face of rising unemployment stick? Will consumers who have traditionally bought these brands change product loyalty? The WSJ reports, P&G, Colgate Hit by Consumer Thrift.

If price checking is not already part of your regular exercise when shopping, it should be. Make no mistake, raising prices at this juncture is a high risk proposition for Colgate, P&G, or any other company. However, do not be surprised to see more slight price increases on staples along with slight declines in product sizes.

What prompted some of these price increases? The WSJ reports:

To offset higher commodity prices and global currency swings, P&G and Colgate raised prices in the quarter through March. P&G said higher prices increased its total sales by 7%. Colgate raised prices by 8%.

Despite pressure from retailers to lower prices for cash-strapped shoppers, neither company conceded much willingness to do so.

Higher prices hurt sales volumes, especially in emerging markets, but still paid off for the companies.

“While painful, pricing to protect the structural economics of our business is the right thing to do,” P&G Chief Financial Officer Jon Moeller said.

Analysts said higher prices could backfire. “Investors are certainly concerned by unit-volume trends, especially on the Procter side, and wondering whether they’re going to have to lower price points or kick up promotions,” said Bill Pecoriello, CEO of ConsumerEdge Research LLC, a consumer-products research boutique in Stamford, Conn.

While impulse buyers like myself are a retailer’s dream, it is obviously prudent to comparison shop. However, if we see ongoing increases in commodity prices and volatility in currencies, (both of which are likely to occur in the face of massive deficit spending), these price increases may be more the norm than the exception.

Don’t be surprised if stockpiling of goods becomes a prudent discipline.

LD

St. Patrick Smiles on the Market!

Posted by Larry Doyle on March 17th, 2009 5:34 PM |

When trading bonds, I used a rule that Tuesday’s price action often reversed Monday’s. While that rule of trading was strictly a quirk based upon years of experience, I found it happen so regularly that I never discounted it. 

Supported by a surprisingly strong housing starts number (+22% to 583K) and a relatively mild increase in PPI (producer price index) of .1%, the market opened relatively flat today but firmed all day right into the close. The major stock market averages closed up 2.5%-4%!! (more…)






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