If the chart below doesn’t grab your attention then few things will. In my opinion, the performance of the dollar is the surest evidence of the kind of environment we’re currently in. The surging dollar is a clear sign that inflation is not the concern of global investors. This is almost a sure sign that deflation is once again gripping the global economy and should be setting off red flags for equity investors around the world.
The recent action in the dollar is eerily reminiscent of the peak worries in the credit crisis when deflation appeared to be taking a death grip on the global economy and demand for dollars was extremely high. The recent 16% rally in the dollar is a sign that investors are once again worried about the continuing problem of debt around the world and they’re reaching for the safety of the world’s reserve currency – the dollar. As asset prices decline and bond yields collapse this is a clear sign that inflation is not the near-term concern, but rather that the debt based deflationary trends continue to dominate global economic trends.
This is exactly the kind of market action we saw leading up to Lehman Brothers. In 2008 the dollar rallied as signs of deflation began to sprout up. This was an instant red flag for anyone who understood the deflationary forces at work (and a total surprise for the inflationistas). The dollar ultimately rallied 26% from peak to trough. Coincidentally, the dollar had rallied 16% from trough to peak just prior to the Lehman collapse when the dollar surge accelerated.
Of course, the inflationistas will argue that gold is rising in anticipation of inflation. In my opinion, this is incorrect. First of all, if inflation were a major global concern the Goldman Sachs Commodity Index wouldn’t be almost 65% off its all-time high and just 33% above its 2009 low. Second, and perhaps most importantly, bond yields around the globe wouldn’t be plummeting if there were rampant inflationary fears. For a much more detailed analysis on the reasons why inflation is not a near-term concern please see here.
As for the gold rally, I think it’s clear gold is rallying in anticipation of its potential to become a future reserve currency. The potential demise of the Euro has become a rally cry for inflationistas who don’t understand that the Euro is in fact another single currency system (like the gold standard) which is destined to fail. In the near-term, the rise in gold is likely justified as fear mongering and misguided governments increase demand for the yellow metal. Ultimately, I believe investors will realize that there is little to no inflation in the global economy and that the non-convertible floating exchange systems (such as the USD and JPY) are fundamentally different from the flawed currency system in place in Europe.
Debt deflation continues to plague the global economy. Thus far, policymakers have been unable to fend off this wretched beast and I attribute this largely to the widespread misconceptions regarding our monetary systems. This extends to the very highest levels of government and the misconceptions regarding the EMU, the Euro and the vast differences in their monetary system have only exacerbated the problems and are likely to further worsen the global deflationary threat. The ignorance on display here borders on criminal in my opinion as governments impose harsh injustices on their citizens due entirely to their own lack of understanding.
I’ve mentioned repeatedly over the course of the last 18 months that government responses to the credit crisis were misguided and unlikely to resolve the structural problems. I’ve also mentioned that this was something I have sincerely hoped I would be wrong about as the consequences have the potential to be enormously destructive. Unfortunately, the policy responses have been so tragically misguided that I now believe the global economy is on the cusp of a potential double dip. And as Richard Koo says, the second dip has the potential to be far worse than the first because investor confidence is shattered (which is clearly the case on the back of the recent market crash). Policymakers are doing little to rectify confidence and have in fact, through their ignorance of the way in which our monetary system actually functions, only increased the global risks in the economy. The dollar is the surest sign of the lack of faith in the policy response and an enormous red flag for risk markets. Allocate accordingly.
PS - There is a video going around called “Melt-up” and it is receiving a HUGE amount of attention on the internet. It is regarding the recent melt-up in stocks and how the U.S. is about to enter an inflationary spiral and a currency collapse. I would recommend to the good readers here at TPC to ignore this video. It is 100% factually incorrect (well, more like 75%) and full of the same fear mongering misconceptions that fuel the asset destroying portfolio strategies of well known inflationistas (we all know the names). Videos like these are based on the same misconceptions regarding the monetary system that have actually led to the current debacle. Positioning yourself for hyperinflation and a U.S. dollar collapse has been a recipe for disaster and will continue to be a recipe for disaster as debt deflation remains the single greatest risk to the global economy.
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Good stuff as usual TPC. You’ve nailed this market and done an incredible job understanding the fundamental drivers. Regarding gold – are you bearish?
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TPC Reply:May 17th, 2010 at 2:50 AM
No. I believe the misconceptions regarding the monetary system are so widespread that they will continue to drive gold prices. It’s impossible to be bearish in the face if this. Not to mention, the actual fundamentals of gold are good. I’m not a hater of gold. I just don’t think it can ever serve as a currency. Any move back to the gold standard would be very misguided and potentially damaging in my opinion.
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boatman Reply:May 17th, 2010 at 7:42 AM
i totally agree….and gold IS the currency of irrational fear….and it is very regretable,scary and sad that sovereign debt will fire this fear.
MMT, the dollar being the worlds reserve currency and warren moseler himself cannot ease the fear factor of the masses.
standing back and looking at the houseing bubble it made no rational sense to me…..and the coming gold bubble has little rational sense.
that’s the point, people are not rational,..(especially when scared)……………. other than me,you, and warren moseler……well most of the time we are anyway.
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Great post, TPC!
Continuing bank and bondholder bailouts will guarantee a dour future for main st. economies of the world.
The real problem is, however, that those in power have little incentive to help main st. After all, politicians/bankers profit by plundering their constituency, so what could change to make this time different? That’s the question!
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TPC Reply:May 17th, 2010 at 2:52 AM
Voting for people who actually understand a thing or two about the economy is a good start!
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It’s called a “flight to safety” or “away from risk” or any number of other similar phrases
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Would agree with some of the points made. Might want to consider this, however…we are NOT seeing deflation in the normally accepted definition. We are seeing asset deflation which is another matter. Was the asset “inflation” that we saw really “inlfation”? If that was NOT inflation, then this is NOT deflation. What you owe on or can owe on is going down in value whereas everything you NEED is going up in price. The deflationists also disregard one other important thing. Hyper inlations are NOT monetary events, they are CURRENCY events.
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TPC Reply:May 17th, 2010 at 3:12 AM
The global deleveraging disproves your point. As for hyperinflation bring a currency event – the move in the dollarand bond market proves this is not an inflationary event.
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John Reply:May 17th, 2010 at 11:04 AM
Market Sniper,
I just read through this article, which I thought was a good one, and the comments and I gota agree with you on the inflation/deflation and assets verses everyday necessities thoughts. When I look at what I have to purchase over the course of a week, month or year, the things I absolutely have to buy, almost every single thing, costs more today then it did last year. Be it home and auto insurance, medical insurance, continuing education expense, or food (which if the price hasn’t gone up the amount your getting is smaller), State and local taxes, licenses, user fees, utilities, real estate taxes. I could go on but what’s the point, it all costs more. Granted homes, whose price increases were not included in the CPI in the first place since they use owners equivalent rent, computers and toasters have gone down, I just don’t happen to buy those things very often. Maybe I just don’t get it but I can’t see much deflation when I have to purchase something. I don’t know how to label this but it sure isn’t 2% inflation or deflation, at least not for most people I know. Funny thing is, everyone I talk to says the same thing.
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prpht9 Reply:May 17th, 2010 at 1:46 PM
TPC,
I agree with John. I don’t feel deflation in my everyday life. Even though I know the value of the US Dollar is increasing.
I see my monthly costs going up and my amount of goods purchased declining. (food, books, phone, cable, education, insurance, health care, etc.) I do see some assets such as home values going down, but typically they are high priced 3-5yr old homes, older large high value homes in prestigious locations and/or commercial real estate. It doesn’t surprise me these assets are dropping in price because I don’t think they were worth that much to begin with, but their going market price was higher than it should have been. This is where I base my “Main St.” perspective. Not off of the CPI or the value of the US Dollar or the Euro, or whatever.
I don’t know how to define what my budget and gut say are inflation. Your article describes the deflationary perspective well so I won’t go into that here, but when larger scale figures point to both inflation from some sides (say, certain categories in the CPI) and deflation from your side. I begin to look for signs from the inflation side. I mentioned some daily life inflation examples and would like to add a couple other points about “Risk of Potential Inflation” not inflation itself.
I am not an expert, but from my perspective the large increase to M1 Currency and the subsequent corresponding increase to the Excess Reserves of Depository Institutions then the Federal Reserve paying banks interest if they keep money in Excess Reserves can be seen as a large “Risk of Potential Inflation”. I believe concern about this risk is reasonable and should be taken into account when thinking about investment and wealth. I don’t think I’m an inflationist. But I have to admit, Congress, the Fed and others have me quite on edge about monetary policy and the future of our system as we know it.
If I were a cartoonist I would draw the Fed holding a large container of cash out over the edge of a cliff saying, “Trust me I won’t drop it”. I’m not saying the Fed can’t do what they claim and keep inflation in check. I’m saying if something untoward should happen. Something unpredictable or unexpected. The risk of large amounts of inflation is out there and much greater than it was prior to late 2008. This is why I believe the platinum/gold/silver bug is spreading over and above the alleged manipulation of the silver bullion markets by JP Morgan and others.
I recognize short term inflation is not a threat and deflation is the norm because everyone is running to safety of the US Dollar like you stated in the article. The difficult part here is to decide how to protect yourself from both deflation in certain areas while protecting yourself from inflation in others. It’s a tough line to walk.
-prpht9
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TPC Reply:May 17th, 2010 at 2:00 PM
I 100% understand why you guys feel this way. But step back and look at the bigger picture. Real estate is still 30% from its highs and near its lows. Stocks are still 30% off their highs. Wages are flat. Lending is down. Jobs are not coming back.
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