Of course, deflation has been rendered little more than the lever needed by chronic inflators as they rationalize the endless bailout through monetary tricks. So disinflation remains a macro economic manipulator’s best friend.
By Steve Saville
The following is excerpted from a commentary originally posted at www.speculative-investor.com on 29th September 2013.
For the entire history of the Federal Reserve prior to October of 2008, the Fed was not legally able to pay interest on bank reserves. However, the Emergency Economic Stabilization Act of 2008 gave the Fed the power to pay interest on reserves and the Fed has since made use of this power. We are going to explain why this change was made and why it greatly reduces the probability of future US deflation.
Deflation Will Take the Majority by Surprise
Google searches offer an insightful glimpse into economic expectations
By Elliott Wave International
The last thing on the minds of most people is deflation. It’s easy enough to determine that with a quick quiz — and that quiz is found in the just-published Elliott Wave Theorist.
In this July-August Theorist, Robert Prechter uses Google searches to make a point about deflation:
Here is the chart we have been using in NFTRH, showing inflation protected T bond fund TIP vs. regular T bond fund TLT.
This ratio has been bottoming for months now and in the last few weeks had made some failed efforts to break out. Last week it closed above the bottom pattern neckline.
From NFTRH 252:
“TIP-TLT can be thought of as a barometer to ‘inflation expectations’. That could be what the precious metals, led by silver, are indicating in tandem with the above ratio. At the very least, it looks like a ‘deflationary expectations’ phase – which helped feed Goldilocks and croak precious metals – may be ending.”
Goldilocks lived by the deflationary pressures that Europe’s meltdown and China’s slow down exerted upon the world. Now, with the latest TICS report showing China and Japan selling T bonds we suddenly have the Fed’s Huey, Dooey and Louie jawboning a ‘taper’ of bond buying in the media. Ha ha ha… as if they have a decision to make.
The Treasury TIC data are only through June, which just happens to be the month we observed the breakout from bottoming patterns in 10 year and 30 year bond yields. But the play always (and I am talking nearly a decade since we began following this dynamic) been that America’s voracious consumption habits would be used to build out the Chinese economy on credit. They would not let us abuse our ability to inflate without consequence forever.
Do they perhaps feel built out enough for the time being? We’ll find out in future TICS reports. But I’ll just say that everybody thinks they know that there is no inflation and in this market what everybody thinks they know could well stand to be wrong. I have rarely seen so many of the right people on the wrong sides.
Last week we noted an upward break but then TIP-TLT closed the week in ‘move along nothing to see here’ mode, i.e. back below the neckline. Now it is back above, which makes sense with the dollar down today but does not make sense with commodities also down. Or does it?
Well yes it does make sense because it is a market that has been fed (no pun intended) intravenously all sorts of unnatural stimuli and no human should pretend to definitively state they know what the outcomes will be. Too many moving parts my friends.
But for now, an indicator that did what it was supposed to do during the 2008 liquidation, the 2009 inflationary recovery, the 2011 inflation top and the Euro crisis mini hysteria has formed a bottoming pattern and is at least flirting with a breakout. If the indicator stays normal, that would indicate inflation effects coming somewhere on down the road. If…
As the credit markets (AKA funding mechanisms) go, so have gone inflated asset markets over the last decade or two, subject to some very rude interruptions. It looks like credit of all kinds is being rudely interrupted right now. Deflation is credit gone into hiding and this time US T bonds don’t seem to be playing ball.
How to play the FOMC? Does it matter beyond “manage risk?” asked the robotic blogger.*
The Fed has been using its jawbones as well as talking out of every other orifice over the last month or two with regard to ‘taper or not to taper’. The stock market is at the moment on a tout that sees them saying ‘never mind about the taper stuff for now. We were just floating a trial balloon to prick the speculative atmosphere’.
The US dollar has been hammered but is now at a support point. Inflationists are wondering why on earth are commodities so weak and precious metals so bearish while Uncle Buck is on the mat like this? And that is a good question.
I am sure many people are thinking that T bond yields are indicating economic growth or at least that inflation is coming, but I am not so sure. There is this man of infinite patience and consistency of message – a super robot* really – who sees higher bond yields as fitting in nicely with a deflationary scenario. That would be Robert Prechter. His view is that yields would not be rising because of the usual ‘inflationary expectations’ or economic growth, but because of impending debt default.
There is that word again; D.E.B.T. and with stocks again soaring amid robust use of margin (yeh, yeh, I have heard all about that money on the sidelines, but much of the money that is playing the market is borrowed). I would have to think that a large proportion of the money on the sidelines is a) being used by individuals and businesses to repair balance sheets and deleverage (deflationary) and b) sitting on the books of banks and other privileged corporations.
This last condition could change if – and it is still a big if – the banks are compelled to put that money to work with the prospect of higher interest rate return (our ‘taper to carry’ thesis).
But in an era when governments competitively try to stave off debt reckoning by compromising currency (some might say the oldest monetary trick in the book), a currency with as much upside potential as the USD – especially after the hard decline of the last month – is not going to prove convenient to the inflationary growth crowd.
This brings me to another thought. You know how Ben Bernanke is public enemy #1 in the gold “community”? Well, was he not once thought of as Helicopter Ben, subject to mockery and ridicule but also depended upon as the great inflator who would personally enrich the community’s members? What if – the brilliant Op/Twist aside – he is the same old Ben but the inflation is just not working? What if he is just as nonplussed as the average gold bug or commodity bull?
I am just asking questions here. The stock market is the last man standing and could be on its final tout as well. Maybe the precious metals blow off in 2011 was the kickoff to a new era where they lead commodities, T bonds and finally stocks, down into a phase where there is only one king and his name is Cash.
The USD is still on a bull signal with the cross of the weekly EMA 10 over the EMA 35. If this is negated then we might watch the monthly for failure. But USD is still bullish until then. We might want to watch the Aussie dollar with respect to any ‘inflation trade’ potential. Crude oil, as already noted, looks bullish for a trade. The majority of the commodity complex is however, in a sad state.
In a deflationary scenario on the other hand, King Dollar – the reserve currency and marker of claims to a world full of assets - would rule. The ruthlessly abused Yen and the Barbarous Relic of monetary value would eventually play roles in a rush to liquidity as well. But I think it would be prime time for Uncle Buck first and foremost for a while.
* Why not stick to what has worked in robotic fashion during a phase when markets appear so screwed up that luminary market players are publicly considering cashing in and leaving the game due to the messed up signals that meddlesome policy, systematic manipulation and investment by machines have injected. In my case what has worked is risk management and risk management only over the last 6 months and really, two years. I’ll stick with it until I get solid data.