Gold Update: The small trade within the big trade

[bart]

Re: Gold Update: The small trade within the big trade

you got it! lying to us in full public view for years... who needs to cover it up with these guys can count on the msm to not cover the story?

The Bubble Cycle is Replacing the Business Cycle

Maybe there's a New Economy after all

by Eric Janszen

Note: this article originally appeared on the AlwaysOn Network, March 13, 2005.

Let's put to rest the myth that the Fed is blind to asset bubbles and never intentionally acts to prick them. The truth can be obtained by anyone with an internet browser and a few hours on their hands to read the voluminous Fed Open Market Committee (FOMC) meeting minutes. In the FOMC meeting minutes from March 22, 1994 (pdf), Greenspan says (my emphasis in italics):

While its very much a non-trivial task, a study of the FOMC minutes is one of my top five items for enabling a broad and full understanding of what's really going on.

Here's the applicable quote from those 1994 minutes:

"So the question is, having very consciously and purposely tried to break the bubble and upset the markets in order to sort of break the cocoon of capital gains speculation, we are now in a position—having done that and in a sense succeeded perhaps more than we had intended—to try to restore some degree of confidence in the System."
-- Alan Greenspan, Chairman of the Federal Reserve.

[Finster]

Re: Gold Update: The small trade within the big trade

The "censorship" is called "moderation" on other sites. Incredibly, we have until recently very, very rarely had to do any. The community pretty well "polices" itself.

As someone who has been at sites with little to no moderation, I am grateful for that which is here!

[Finster]

Re: Gold Update: The small trade within the big trade

You, or one of you FRED's, made it somewhat clear that there would be some on-going censorship here from yesterday. As an aside that pains me, but pertinent to the moment is that I would like someone, if someone exists, to cast Williams' perceptions with a negative light, i.e. say that he is wrong in something he wrote. And I am not asking the iTulip staff or EJ to do that, but it seems someone here in the audience would see something wrong with what Williams wrote. And I sure would like to read something by someone smart enough to argue against his perceptions.

Finster: [raises hand]

No, I don't presume to meet all your specifications, but do "see something wrong with what Williams wrote". For the record, I think very highly of Williams and don't lightly disagree with him.

My problem with this article is not the general direction of the scenario, but with the extremes. There will be inflation, maybe hyperinflation, but Williams is specific in calling for "seven- to 10-digit inflation". And it seems likely to take longer to evolve than he envisions.

Why? Partly because there seems to be a historical tendency for very extreme forecasts to not pan out. I remember the late 1970s well, when many people were stockpiling freeze-dried food and burying gold in the yard in preparation for a total breakdown of civilization. Hyperinflation had been forecast by some very smart people. And inflation did get very bad, but somehow we pulled ourselves back from the precipice.

And partly because of sheer inertia. There remains a massive amount of widely and deeply distributed debt in the US, and that debt represents demand for dollars. Yes, armed with printing presses and helicopters, the authorities can overwhelm that demand with supply, but there is enough of a distribution problem to make it unlikely the inflationary process will accelerate so fast as Williams postulates.

I'm not saying his outlook could not come to pass. Just that it's not likely to get as severe as he prophesies or that quickly.

[Nervous Drake]

Re: Gold Update: The small trade within the big trade

.

[Finster]

Re: Gold Update: The small trade within the big trade

... Even his statement about a 90% loss (net of inflation) in US stocks isn't terribly different from the return to the mean that EJ has noted many times... and even my own chart of the CPI+lies adjusted Dow supports a 90% hit. The CPI+lies inflation adjusted mean is 1000-2000. The CPI only inflation adjusted mean is very roughly 3000-4000. Just to be clear too - that does not mean that the Dow will get that low. It could go to 30,000 or even much higher on a nominal basis...

This is an especially good point, Bart. Net of inflation, 90% stock market losses are not as extreme as they may sound. 1929-1932 set the market back about 90% in (both nominal and) real terms. 1968-1980 stock prices nominally went about net sideways, but in inflation adjusted terms, were down around 90%. 2000-date the stock market is already down over 40%, and 90% looks highly likely again this time.

[jk]

Re: Gold Update: The small trade within the big trade

since the discussion of the probability of williams' scenario has migrated to this thread, i am taking the liberty of reposting a comment i made in the other thread:

-----

there is a case williams did not consider: that at some point the fed RAISES rates to support the dollar. the argument would be that by the time of williams' hypothesized monetization, long bonds would have sold off and thus long rates would be quite high. if at that juncture the fed raises rates, the dollar would be supported and - hypothetically- long rates might come down some, flattening the curve a bit and, overall, reducing the treasury's cost of borrowing. perhaps, in order to facilitate this, the fed will buy long bonds in order to inject money, instead of buying tbills. we know that bernanke discussed this very possibility in his "keeping 'it' from happening here" paper.

so, to recap, imagine the fed raising short rates while buying long bonds. this might cause the unwinding of the dollar carry trade which is appearing now, and thus support the dollar even more strongly.

the concern, of course, is that higher short rates would hurt the economy, but in this scenario, i think it would be a preferable policy.

i think this is the kind of "creative intervention" that goes along with the multiple targeted lending facilities that the fed has pulled out of its hat recently. and i would add that this might drop the price of oil and other commodities not just by reducing demand, but by killing the dollar/oil, dollar/agric, dollar/metals carry trades.

[c1ue]

Re: Gold Update: The small trade within the big trade

JK, Bart, Finster,

Your collective points on how things might not be as bad are all quite reasonable.

However, the question I ask is whether the US can simultaneously inflate away its debt while also not losing its present dependence on imports.

I can also see lots of scenarios where the dollar will remain at some lower bound in order to prevent complete trade cutoff, but I still fail to see how a partial inflation policy will resolve the debt issue.

Perhaps I am being too simplistic - but I have been and continue to view the issue as being how to either inflate away the present debt pyramid and eventually finding out how to live without the massive imports presently being paid for with said debt, or finding out how to survive without imports immediately.

Unless this simplistic scenario is false, I would foresee either choice as being of the same result, only different timeline and somewhat different impact.

[jk]

Re: Gold Update: The small trade within the big trade

i've read that with old-fashioned inflation numbers used for the annual adjustments, social security payments would be 70% higher. so part 1 of the "solution" is to continue understating inflation. part 2 will be means testing social security and medicare. we'll need to be in a hell of a crisis for that to be politically do-able, but herb stein's famous dictum applies. [if something can't go on forever, it will eventually stop.] part 3 is that other currencies also lose value, cushioning the appearance of the dollar's drop in purchasing power. step 4, at some point the fed raises rates to support the dollar, perhaps while buying long paper, as i've suugested. but this can only be done AFTER there has been enough inflation to lower the burden of debt. remember, there is too much debt: it cannot be paid at full value, so it will be paid in itty bitty dollars.

step 2 is key- without it there must be even higher inflation. a key point in williams' analysis is political -- that these obligations are not diminished by legislation. but they will have to be diminished in some fashion.

step 4 allows the fed to put the brakes on the inflationary process. the prior devaluatio0n of outstanding debt prevents this from triggering a deflationary spiral. [i hope]

[Finster]

Re: Gold Update: The small trade within the big trade

JK, Bart, Finster,

Your collective points on how things might not be as bad are all quite reasonable.

However, the question I ask is whether the US can simultaneously inflate away its debt while also not losing its present dependence on imports.

I can also see lots of scenarios where the dollar will remain at some lower bound in order to prevent complete trade cutoff, but I still fail to see how a partial inflation policy will resolve the debt issue.

Perhaps I am being too simplistic - but I have been and continue to view the issue as being how to either inflate away the present debt pyramid and eventually finding out how to live without the massive imports presently being paid for with said debt, or finding out how to survive without imports immediately.

Unless this simplistic scenario is false, I would foresee either choice as being of the same result, only different timeline and somewhat different impact.

See below...

i've read that with old-fashioned inflation numbers used for the annual adjustments, social security payments would be 70% higher. so part 1 of the "solution" is to continue understating inflation. part 2 will be means testing social security and medicare. we'll need to be in a hell of a crisis for that to be politically do-able, but herb stein's famous dictum applies. [if something can't go on forever, it will eventually stop.] part 3 is that other currencies also lose value, cushioning the appearance of the dollar's drop in purchasing power. step 4, at some point the fed raises rates to support the dollar, perhaps while buying long paper, as i've suugested. but this can only be done AFTER there has been enough inflation to lower the burden of debt. remember, there is too much debt: it cannot be paid at full value, so it will be paid in itty bitty dollars.

step 2 is key- without it there must be even higher inflation. a key point in williams' analysis is political -- that these obligations are not diminished by legislation. but they will have to be diminished in some fashion.

step 4 allows the fed to put the brakes on the inflationary process. the prior devaluatio0n of outstanding debt prevents this from triggering a deflationary spiral. [i hope]

This is more than plausible, JK. Some historical perspective: Before, government obligations and those of other debtors could be reduced by means of inflation. Pay the dollar value of benefits and debts, but pay them in depreciated dollars. This is the usual mode of soveriegn default. But those having claims on those benefits and debts noticed, so the government eventually began indexing them to the CPI or other indices of inflation.

Of course this merely recreated the original problem when debts and obligations again grew beyond the ability of the government to pay. This meant they couldn't be inflated down unless the rate of inflation exceeded the rate of indexing - this margin then became the "new" inflation. We then reach a sort of "inflation squared" scenario where there is a new deception added on top of a fix for the old deception.

In any event, this does give the authorities a means to inflate away debt. It's not so critical that the rate of inflation itself reach a certain level nor that the rate of indexing reach a certain level, but rather that the difference between the two be adequate to serve the purpose the original inflation did.

Depending on how you reckon the real rate of inflation, that difference is already at least in the upper single digit range. Around 8%, for example, using William's SGS calculations versus those of the government's BLS. Provided the rate at which new debt and obligations are added is not too high, it does seem possible that the real debt level could be reduced to manageable levels given sufficient time.

Those provisos of course are far from trivial, but there is at least a path whereby catastrophic hyperinflation can be averted.

[bart]

Re: Gold Update: The small trade within the big trade

i've read that with old-fashioned inflation numbers used for the annual adjustments, social security payments would be 70% higher. so part 1 of the "solution" is to continue understating inflation. part 2 will be means testing social security and medicare. we'll need to be in a hell of a crisis for that to be politically do-able, but herb stein's famous dictum applies. [if something can't go on forever, it will eventually stop.] part 3 is that other currencies also lose value, cushioning the appearance of the dollar's drop in purchasing power. step 4, at some point the fed raises rates to support the dollar, perhaps while buying long paper, as i've suugested. but this can only be done AFTER there has been enough inflation to lower the burden of debt. remember, there is too much debt: it cannot be paid at full value, so it will be paid in itty bitty dollars.

step 2 is key- without it there must be even higher inflation. a key point in williams' analysis is political -- that these obligations are not diminished by legislation. but they will have to be diminished in some fashion.

step 4 allows the fed to put the brakes on the inflationary process. the prior devaluatio0n of outstanding debt prevents this from triggering a deflationary spiral. [i hope]

I submit that step 3 is the one that does not receive enough attention, allows too much tunnel vision, and excess focus on the demise of the US dollar.

There is no country on Earth that is not inflating, and more than a few are also in double digits like the US.

[Finster]

Re: Gold Update: The small trade within the big trade

There is no country on Earth that is not inflating, and more than a few are also in double digits like the US.

Bingo! This is crucial. This is why the declines in "the dollar" don't quite seem to fully account for all these price increases. The dollar falls, say 9% against the euro. But prices rise 14%. Well ... maybe the euro itself lost 5% in value! After all, Mr. Trichet seems greatly concerned about just that, resisting cutting ECB rates precisely because the purchasing power of the euro is falling too fast for the ECB's mandate.

[bart]

Re: Gold Update: The small trade within the big trade

Bingo! This is crucial. This is why the declines in "the dollar" don't quite seem to fully account for all these price increases. The dollar falls, say 9% against the euro. But prices rise 14%. Well ... maybe the euro itself lost 5% in value! After all, Mr. Trichet seems greatly concerned about just that, resisting cutting ECB rates precisely because the purchasing power of the euro is falling too fast for the ECB's mandate.

I know you've seen this before, but it seems particularly salient now. Its far from perfect and does not take things like CPI+lies into account, but it sure does show the basic truth.

[c1ue]

Re: Gold Update: The small trade within the big trade

Gentlemen,

I understand where you are going with this line of reasoning.

The trouble is that if the $60T debt is anywhere close to real, then with a simple expectation of interest rate paid of 3% yields some ugly numbers. Note: I think this is a very low assumption given inflation.

At 3% interest, we're talking about $1.8T in payments per year.

Couple this with the continuing large trade deficits ($763B in 2006), we're now looking at a net of over $2.5T.

Granted, US GDP is over $13.5T, but $2.5T in cash payments vs. $13.5T of all dollars earned in the US is not a comforting ratio. If I use money velocity as a rough approximation of 'productivity velocity' and divide GDP by it to yield a rough approximation of cash carry capability, that looks REALLY ugly.

Even with a nominal 8% net devaluation rate (3% interest, 11% inflation), it would take 9 years to cut existing $60T to the present equivalent of $30T (rule of 72 in reverse).

So, if the trade deficits can be erased, even then we're looking at 9 years where in year 1 13% of all dollars earned go to paying debt (interest only). Alternately 18% of all dollars earned would be going to paying debt and buying crap from other countries.

In year 9 the interest carry is still 6.5% of GDP.

Obviously the actual rate being paid could be higher or lower, but only an interest rate of 1% or less would yield a comfortable scenario.

Actual interest rates paid of 5% or more would be ruinous.

Of course, in reality creditors don't stand still when their principal is being eroded. The real reason inflationary spirals go asymptotic is that creditors sooner or later start demanding interest payments in excess of past inflation in order to get ahead of future inflation.

Then there is the question of the upcoming 'Boomer bulge' in anticipated payments. The Boomers are more than large enough to swing politics their way, perhaps it will be necessary to 'clean the decks' of existing debt before this demographic starts demanding their entitlements - which means a 75% or 90% reduction in purchasing value by 2011.

[BiscayneSunrise]

Re: Gold Update: The small trade within the big trade

We are hearing from some of our members who are trading gold that they are buyers again at $850. We are still above the $200 decline that this analysis speculated on March 5, 2008 that implies a bottom price of $780 for the small trade within the big trade.

Thanks Fred, I know we are close and I was badly tempted to jump back in after the May 1st decline but am still holding back.

Some say the markets are beginning to look across the valley now and equities (X-financials) should do well for the medium term. I share those sentiments. I know Eric thinks it is to soon although in the "Buy Ford " thread he indicated that over the very long term, equities in the right spots should do better than PM's.

Is that still the sentiment? Being an anti-doomer, I struggle with re-entering the PM trade when seeing all the really great innovation that is out there creating wealth.

[Finster]

Re: Gold Update: The small trade within the big trade

I know you've seen this before, but it seems particularly salient now. Its far from perfect and does not take things like CPI+lies into account, but it sure does show the basic truth...

Donka. Illustrates your point about currencies all tending to decline nicely. Moreover, seems pretty safe to say that if we did "take things like CPI+lies into account", the US Dollar would look a little less like gold and the Swiss Franc, and little more like the German (Wiemar) Mark and the French Franc ...