Bonds & Interest Rates
Dedicated readers of The Wall Street Journal have recently been offered many dire warnings about a clear and present danger that is stalking the global economy. They are not referring to a possible looming stock or real estate bubble (which you can find more on in my latest newsletter). Nor are they talking about other usual suspects such as global warming, peak oil, the Arab Spring, sovereign defaults, the breakup of the euro, Miley Cyrus, a nuclear Iran, or Obamacare. Instead they are warning about the horror that could result from falling prices, otherwise known as deflation. Get the kids into the basement Mom….they just marked down Cheerios!In order to justify our current monetary and fiscal policies, in which governments refuse to reign in runaway deficits while central banks furiously expand the money supply, economists must convince us that inflation, which results in rising prices, is vital for economic growth.
Simultaneously they make the case that falling prices are bad. This is a difficult proposition to make because most people have long suspected that inflation is a sign of economic distress and that high prices qualify as a problem not a solution. But the absurdity of the position has not stopped our top economists, and their acolytes in the media, from making the case.
A January 5th article in The Wall Street Journal described the economic situation in Europe by saying “Anxieties are rising in the euro zone that deflation-the phenomenon of persistent falling prices across the economy that blighted the lives of millions in the 1930s-may be starting to take root as it did in Japan in the mid-1990s.” Really, blighted the lives of millions? When was the last time you were “blighted” by a store’s mark down? If you own a business, are you “blighted” when your suppliers drop their prices? Read more about Europe’s economy in my latest newsletter.
The Journal is advancing a classic “wet sidewalks cause rain” argument, confusing and inverting cause and effect. It suggests that falling prices caused the Great Depression and in turn the widespread consumer suffering that went along with it. But this puts the cart way in front of the horse. The Great Depression was triggered by the bursting of a speculative bubble (resulted from too much easy money in the latter half of the 1920s). The resulting economic contraction, prolonged unnecessarily by the anti-market policies of Hoover and Roosevelt, was part of a necessary re-balancing. A bad economy encourages people to reduce current consumption and save for the future. The resulting drop in demand brings down prices.
But lower prices function as a counterweight to a contracting economy by cushioning the blow of the downturn. I would argue that those who lived through the Great Depression were grateful that they were able to buy more with what little money they had. Imagine how much worse it would have been if they had to contend with rising consumer prices as well. Consumers always want to buy, but sometimes they forego or defer purchases because they can’t afford a desired good or service. Higher prices will only compound the problem. It may surprise many Nobel Prize-winning economists, but discounts often motivate consumers to buy – -try the experiment yourself the next time you walk past the sale rack.
Economists will argue that expectations for future prices are a much bigger motivation than current prices themselves. But those economists concerned with deflation expect there to be, at most, a one or two percent decrease in prices. Can consumers be expected not to buy something today because they expect it to be one percent cheaper in a year? Bear in mind that something that a consumer can buy and use today is more valuable to the purchaser than the same item that is not bought until next year. The costs of going without a desired purchase are overlooked by those warning about the danger of deflation
In another article two days later, the Journal hit readers with the same message: “Annual euro-zone inflation weakened further below the European Central Bank’s target in December, rekindling fears that too little inflation or outright consumer-price declines may threaten the currency area’s fragile economy.” In this case, the paper adds “too little inflation” to the list of woes that needs to be avoided. Apparently, if prices don’t rise briskly enough, the wheels of an economy stop turning
Neither article mentions some very important historical context. For the first 120 years of the existence of the United States (before the establishment of the Federal Reserve), general prices trended downward. According to the Department of Commerce’s Statistical Abstract of the United States, the “General Price Index” declined by 19% from 1801 to 1900. This stands in contrast to the 2,280% increase of the CPI between 1913 and 2013
While the 19th century had plenty of well-documented ups and downs, people tend to forget that the country experienced tremendous economic growth during that time. Living standards for the average American at the end of the century were leaps and bounds higher than they were at the beginning. The 19th Century turned a formerly inconsequential agricultural nation into the richest, most productive, and economically dynamic nation on Earth. Immigrants could not come here fast enough. But all this happened against a backdrop of consistently falling prices.
Thomas Edison once said that his goal was to make electricity so cheap that only the rich would burn candles. He was fortunate to have no Nobel economists on his marketing team.They certainly would have advised him to raise prices to increase sales. But Edison’s strategy of driving sales volume through lower prices is clearly visible today in industries all over the world. By lowering prices, companies not only grow their customer base, but they tend to increase profits as well. Most visibly, consumer electronics has seen chronic deflation for years without crimping demand or hurting profits. According to the Wall Street Journal, this should be impossible.
The truth is the media is merely helping the government to spread propaganda. It is highly indebted governments that need inflation, not consumers. But before government can lead a self-serving crusade to create inflation, they must first convince the public that higher prices is a goal worth pursuing. Since inflation also helps sustain asset bubbles and prop up banks, in this instance The Wall Street Journal and the Government seem to be perfectly aligned.
The article above was taken from the January edition of Euro Pacific Capital’s Global Investor
Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show.
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“World War II marked the end of the British Empire and the pound as the reserve currency. The monetary forces of deflation may have ended the US Empire. In its frantic effort to hold back the forces of deflation, the Federal Reserve has created trillions of federal reserve notes.
Against this tide of liquidity, the dollar, so far, has held its own. I’ve been saying that the dollar is the Achilles heel of the US economy. As long as the dollar index holds above 78, I think it will continue as the world’s reserve currency. I believe one of two positions will occur in the near future: either the dollar will begin to break down, or interest rates will rise. Either course will set off a parade of mishaps.
Meanwhile, the newspapers are filled with stories about the US economy. But we read very little about the rising ocean of debt. It takes money to carry debt, and this in itself is deflationary. Therefore I see the year 2014 as a key year in US history.
All serious investors know that the US is facing a debt predicament. If so, what is the answer? We know that the current expansion of debt in the US is unsustainable. We also know that governments will do anything they have to — to remain in power. So what, I ask, are we going to do about our compounding debt? The newspapers are filled with talk and gossip about business and profits, but not a word about the exploding debt.
Could the US simply announce that it is going to renege on its debt? To most serious analysts, that would be unthinkable. The Russell view is that the whole monetary system could come apart. And if it does, the entire world would be affected. I believe a new monetary system would have to be invented.
At present, it seems to me that the overriding trend is to “get out of dollars,” and maybe to spend dollars on US goods and assets. Buy US corporations, land, real estate and even New York apartments.
In the coming nightmare mishmash, serious money will want to be in the safest of all currencies, and by that I mean gold. If the current monetary system comes unglued, I believe the big investors of the world will go for the gold.
My own stance is to stand aside and watch history unfold. I’m not sure why, but I believe that this year is the year when the excrement hits the fan. My instinct is to be in gold and pray that it all turns out for the best. I think one of the main issues of the year will be the incredible disparity in income between the wealthy 1% and the rest of the population. I believe a second bone of contention will be computers and robots taking the place of middle and lower class laborers.
As I see it, we are in the latter stages of a bull market. My feeling is that this long bull market will end in an absolute explosion of excitement as prices rise to unbelievable heights. We are not there yet, but the trend is up, and we have not seen the end of the melt-up. From this point on, I believe matters will accelerate, and time will be shortened. The year 2014 should end up as one hell of a year.
Meanwhile, gold closed higher and the entire universe of gold ended across the board higher (Friday). With each passing day, gold is shining brighter.
It’s a mystery how many items can be manipulated – gold, short rates, bonds, long rates, the stock market, the dollar, the CPI, and the economy. All of these are being juggled. The overall situation is unsustainable. Some area is going to give, and my guess is that the dollar will be first. Meanwhile debt continues to expand in almost every area. The Fed now owns over $4 trillion in assorted bonds. How they’re ever going to get rid of this mountain of debt is beyond me.
Overall, the Fed’s nonstop creation of dollars is creating an avalanche of liquidity, and it’s liquidity that’s driving the stock market higher. As I see it, the picture is one of a market melt-up that will not be denied. It reminds me of a child’s game of building blocks, piling block upon block, until one last block topples the structure. Valuations are ignored in this historic melt-up.
Money managers cannot afford to be out of the melt-up and they’re not thinking of answers to the build-up. Their only thought is to be part of this year’s rising tide. The tide will continue rising until the structure is so top-heavy that it tumbles over. I don’t know how the mountain of rising debt will be solved. It’s like a force of nature that seems to be unstoppable. Could the US simply announce to the world that it cannot pay its debts? That would be tantamount to bankruptcy and would result in a loss of the dollar as a reserve currency. But is there another way out? If something is unsustainable it must have an end. The build-up of debt in the US is unsustainable. But the stock market could not care less. It is caught in a psychological melt-up that will not be denied.
As I see it the year 2014 will be a headline in the history of the United States. Who to blame our unsustainable position on? My choice – fiat money. Fiat money created by the Fed. Obviously the stock market cares about only one thing: liquidity, as created by an out of control Federal Reserve.
I have a lot of new subscribers, and they have not seen or read any of my WWII stories…
Last night I went to a party. It was given by a lady who is the CEO of a large start-up company. The wealthy venture capitalist who was backing the start-up was there too, along with about six other people. Nobody at the gathering was over 50, most were in their late 30s and 40s. We finished a delicious appetizer, and somehow the talk drifted to Italian wines. It seems, the venture capitalist was an expert on Italian wines. He told us that he had just purchased a great case of a rare Italian wine with a cost of just over one thousand dollars. I wasn’t particularly interested in the wine stories. The wine tales droned on, and I started to doze …
Wine, Italian wine. Spumante. The voices at the party fade. My mind drifts off to another time and another place. I’m in Italy. It’s 1945. We’ve just returned from a difficult mission, and our nerves are still on edge. We’re on a pebbly beach on the shores of the Adriatic Sea. My Pilot, Art Herron, is with me along with our tail gunner, big Hank Buhrmaster. We’re watching an Italian family as they unwrap their picnic baskets. They bring out bottles of wine. It’s Italian wine. They’re drinking Spumante, which is a light, sparkling Italian wine, much like a carbonated sauterne. There aren’t a lot of spirits to drink in Italy here in 1945 — except for cheap Spumante and dry vermouth. No hard liquor at all. No whisky and no ice.
I watch the Italians tie thin ropes around the necks of their bottles of Spumante. Then they toss the bottles into the sea to keep them cool. They wrap the other end of the ropes around large rocks. Clever, I think — I’ve never seen people do that before. After an hour in the hot Italian sun we decide to take a swim. We strip to our shorts (we don’t have bathing suits), and slide into the cold Adriatic water.
When I’m about 10 feet from the shore, I see something floating in the water. It appears to be a log. I paddle closer. It’s a body floating face down in the water. I move still closer. The body is headless — a long streamer like a strand of spaghetti trails out from its headless neck. I call Art over. We see that it’s the body of a German airman. We immediately recognize the uniform — he’s an officer. He must have been shot down at sea and now he’s floating to shore.
The German is wearing a pistol. I wonder whether it’s a Luger, which is much wanted by every G.I.. I move up to the body, and with an effort I undue the holster (the leather is wet). I tug at the pistol. It’s not a Luger, it’s a P-38. (The P-38 is a standard German side-arm that has been manufactured by Nazi slave labor). I work the P-38 out of its holster and return with it to shore. Art looks at it and says, “Too bad it wasn’t a Luger.”
I look back. The body of the dead German bobs up and down with the undulation of the waves. The Italian family is busy eating, they don’t pay any attention to the body. We move down the beach about 30 yards and continue our swimming. It’s no shocker. Corpses are no novelty in war-torn Italy in 1945. Nevertheless, I feel slightly nauseous. Maybe I should have left the P-38 with the poor dead German. I think, “He was somebody’s son and maybe the father of children.” I still have the P-38 pistol today.”
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From Société Générale strategist Andrew Lapthorne comes the chart and the observation that “it has been 408 days since the last 10% correction in the MSCI World index, the 8th longest period on record.”
Saudi Oil Minister Ali al-Naimi said he viewed the increase in U.S. oil production as a new source of supply that will help stabilize oil markets. Oil from shale is providing a buffer against an unsteady Middle East market, but it’s not too early to consider what happens to markets after the revolution.
Naimi said during a meeting in Riyadh with U.S. Energy Secretary Ernest Moniz the increase in U.S. oil production was adding a level of stability to an international oil market unsettled by problems in the Middle East and North Africa.
“It is necessary to continue consultations between our two countries to expand the horizons of cooperation, including joint investments, and working with oil producing and consuming countries for the stability of the global market,” a statement from the official Saudi Press Agency said.
Related article: The Fracking Revolution: Promise and Perils
The U.S. Energy Information Administration said in its short-term market report that production from countries outside the Organization of Petroleum Exporting Countries is expected to increase by a record 1.9 million barrels per day this year. Most of that increase is expected from North America. By next year, U.S. oil production should break a 43-year-old record with 9.3 million bpd.
With a leading consumer producing more of its own oil, Saudi Arabian Oil Co. has the breathing room it needs for Februarymaintenance at its 750,000 bpd Shaybah oil field. Oil production from Saudi Arabia, OPEC’s leading supplier, declined 3.5 percent from the third quarter of 2013 to settle at 9.6 million bpd during the fourth quarter, leaving plenty of room for U.S. production growth.
U.S. oil production gained traction just as Libya’s position in the marketplace fell because of civil war. Nearly three years ago, the International Energy Agency called on member states to release oil from their strategic reserves to offset declines from Libya. With Libya still struggling to return to pre-civil war oil production levels, the conversation is different because of oil from North America.
Without erasing U.S. legislation enacted in the wake of the 1970s Arab oil embargo, crude oil produced in the United States should stay within the domestic economy. By 2035, the United States should be self-reliant in terms of energy, according to BP’s annual economic outlook. But that year may mark the zenith of a brief revolution.
Related article: Lukoil Deal Makes Bulgaria Largest Eastern Europe Refiner
BP said in its report the United States should overtake Saudi Arabia this year in terms of oil production. By Riyadh’s own account, that comes as something of a relief as it addresses changes to its own market dynamics brought on by an increase in regional energy demand. For OPEC as a whole, its share in the oil market declines for much of the decade but recovers by 2020 as U.S. oil production slows down. BP’s report suggests U.S. oil production, meanwhile, falls by 75 percent through 2035.
Decline in U.S. shale production, and the inability of other countries to replicate the success, is not so much validation of peak oil theory as much as it is a return to the status quo, where Middle East and North African producers dominate the market. BP’s report, meanwhile, said oil shows the slowest growth in long-term market forecasts compared with natural gas. With renewables also gaining strength, a future energy market may count oil as a second-tier fuel source. The shale revolution in the United States, as with any revolution, will be brief. It’s what happens after the revolution ends that matters.
By. Daniel J. Graeber of Oilprice.com
Benefit From the Latest Energy Trends and Investment Opportunities before the mainstream media and investing public are aware they even exist. The Free Oilprice.com Energy Intelligence Report gives you this and much more. Click here to find out more.
With your local friendly asset-gatherer constantly promoting the cheapness of stocks of the TINA (there is no alternative) to BTFATH, TV talking-heads jabbering over ‘stock-pickers’ markets (infuriating Cliff Asness), and CEOs trotted out day after day to espouse how bright the future looks (even if outlooks in the immediate future are down-down-down-graded); it is hardly surprising that sentiment among the sheeple is so extremely bullish. So, when we saw the chart below… we could only ask – what do the insiders know that the average-joe-investor doesn’t?
Of course, we are sure someone will try and explain away this avalanche of insider-selling with “tax-related” factors or “taking-profits” but none of that negates the less-than-optimistic tone that it implies about what the short- or medium-term expectations are from management of the firms that comprise the US equity market…
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