Reflation Fantasy

Good Afternoon Folks!

I was going to mainly talk about the automotive debacle today but I have decided to change my mind after picking up some new data.

My take on the GM/Chrysler saga is its about time! Obama finally grew a set and said NO to corporate America. We don't have the money to continue these ridiculous bailouts and perhaps the government is finally realizing this. Kudos to Obama on this one.

Now I realize this is a sensitive issue with some you especially if you are from the Midwest. Whats happened to our car industry is tragic. However, we are running out of money fast folks and its time to make tough decisions.

What I want to know is when do the bank CEO's start getting fired? Why do they get to stay in power? Why is Ken Lewis still the CEO of Bank of America after costing the taxpayer tens of billions of dollars? This is what makes me livid. GM and Chrysler are asking for pennies compared to what AIG has cost us. Why isn't AIG being forced into BK!? This is the largest black hole of them all!

I have no problem offering loans to the automotive companies as long as their restructuring plans makes fiscal sense. The problem is they continue to hemorrhage money despite their drastic cutbacks. Our government should not be in the business of subsidizing companies that lose billions of dollars every quarter.

Putting them into bankruptcy is the only solution here IMO. GM can't get their cost structure in line right now because the bondholders and unions have too much leverage without them being in BK.

This is going to be a long ugly process but I think its the best decision given the circumstances. Lets be clear about one thing here: This 30-60 day short term BK idea that's being floated around by The White House is nothing but a pipedream. The bankruptcy process is a long one and cannot be done in a month or two. There are simply too many issues that need to be decided on especially given how large these companies are.

It will be interesting to see how this all plays out.

Reflation Trade: In your dreams

Alright lets get back to the macro side of this whole economic mess. It appears the reflation trade is about to fall apart. I had suggested about a month ago that the reflation trade would be the play once the pigmen were successfully able to spin the belief that an "economic recovery" was just around the corner. I know I know...Silly bulls!

I had mentioned that shorting commodities would be a nice opportunity once the bulls realized that the economy is going nowhere as demand falls off a cliff.. $50 was the magic number I was looking for on oil.

Many on the street are screaming about inflation concerns as we begin to start dropping money out of helicopters. This will be a problem down the road but right now folks I just don't see it.

Deflation is still the biggest concern as far as I am concerned because wages are collapsing. The Fed is throwing money out of helicopters, but its going to the banks not the consumer. The banks are then hoarding it in an attempt to fix their balance sheets. This means its not getting out into the real economy. Wages must rise in order to see long term inflation and as you can see below its just not happening.

Wages and income from assets continue to freefall:

At the same time: Personal savings is soaring

Final Take:

In order for inflation to take hold people need to have the ability to pay increased prices. As you can see in the first chart, both incomes and incomes from assets have completely collapsed. If prices begin to rise as incomes collapse, demand will simply disappear. When this occurs commodities will drop in price as a result. Its econ 101: Supply and Demand! A perfect example of this was last year when oil went to $147 a barrell. Two months later oil dropped to $40 because demand fell off a cliff.

The one thing that I hadn't really thought about too much before seeing this chart was the whole fixed income dropoff as a result of the nearzero interest rates. You can thank the Fed for collapsing income from assets. Income from assets includes all types of fixed income from things like munies, treasuries, and bank CD's. All of them fluctuate based on the interest rates set by the Fed.

Of course who is the big winner with zero rates? The banks because they don't have to pay as much interest on capital like CD's. Who loses? Retirees and anyone else who is in fixed income. Gee...Banks win and the taxpayer loses...What a shocker eh? Yeah right.

So what we have here is a double whammy on wages. People are making less at their jobs and earning less on what they have saved. On top of that, if you look at the second chart you can also see that the savings rate has soared in the past year. This is another deflationary pressure on prices.

Bottom Line:

So to sum it all up: Consumers are making less money at their jobs, hoarding cash even though they are making less, and earning less on what they have saved. On top of all this, they are also drowning in debt! This combination makes the argument for deflation a very powerful one.

I mean jeeez....Can you say consumer collapse? Can one of the bulls please explain to me how a consumer based economy recovers in this type of scenario? Reflation my ass!

Inflation could be a threat down the road as supply and production drop dramatically. This will eventually make assets more scarce and thus susceptible to price inflation. This is 1-2 years down the road IMO because there is such a glut of supply everywhere.

The reality for now is there are tankers of oil that are sitting in ports with nowhere to go because demand has collapsed as a result of the economy beingdeader than a doornail. Oil has moved from $30-50 on the reflation trade. I think its way overdone here.

USO is a great ETF that you can use to short oil if you want to make a play on weak demand.

Ugly day today in the markets. Lets see what kinda follow through we see tomorrow.