Saturday, August 8, 2009

Fleckenstein and Faber

I will have a quick take on the article below with my usual "The Bottom Line" section at the end of this post.

Let me preface this by saying this is probably the best article I have read around inflation vs. deflation. It was written my one of my favorite market commentators Bill Fleckenstein. He does a wonderful job in this piece highlighting some brilliant insight on the inflation/deflation debate from famed economist Marc Faber.

I rarely highlight a whole article, but this one is a must read from beginning to end IMO:

"Last week's 26-year high in the price of sugar must have stuck in the craw of the deflationist camp, those who fear a bout of falling prices. And that's as good a segue as any to the inflation-vs.-deflation debate.

I've spilled plenty of ink on this important topic (for example, read "What's next: Inflation or deflation?"), and this week I'd like to turn to a friend of mine, Marc Faber, for his assessment.

Marc's most recent Gloom, Boom & Doom Report contains an excellent discussion of inflation vs. deflation, and he makes the connection between the policies we're pursuing -- massive stimulus to create inflation, due to the fear of deflation -- and the funding crisis that I have warned about that will arrive as the U.S. has trouble financing its increasing debt. (Read "Why creating jobs is so hard.")

I decided to quote liberally from Marc's report. But I encourage folks to read it in its entirety. (Here's the Gloom, Boom & Doom Web site; a subscription is required.)

For newer readers who continue to ask me to elaborate on this subject, hopefully Marc's commentary will bring them up to speed:

"Deflation can be avoided through debt and money printing. This isn't to say that I support such policies, or that I find deflation to be "bad" and inflation to be "good." (Price stability is the most desirable condition.) But the point is that if a government is really determined to inflate its problems away, it can be done. Those people who believe in deflation have, however, some strong arguments. Their principal contention is that the economy is so weak (output gap) that the private sector's contraction cannot be offset by government spending and money printing."

In fact, the massive money printing and the rest of the stimulus are why gross domestic product has held up as well as it has. More from Marc:

"The deflationist argues that, because we have a weak economy, we shall have deflation; an argument with which I would tend to agree in the very short term."

For newer readers who continue to ask me to elaborate on this subject, hopefully Marc's commentary will bring them up to speed:

"Deflation can be avoided through debt and money printing. This isn't to say that I support such policies, or that I find deflation to be "bad" and inflation to be "good." (Price stability is the most desirable condition.) But the point is that if a government is really determined to inflate its problems away, it can be done. Those people who believe in deflation have, however, some strong arguments. Their principal contention is that the economy is so weak (output gap) that the private sector's contraction cannot be offset by government spending and money printing."

In fact, the massive money printing and the rest of the stimulus are why gross domestic product has held up as well as it has. More from Marc:
"
"The deflationist argues that, because we have a weak economy, we shall have deflation; an argument with which I would tend to agree in the very short term'

A true deflationist will also argue that because of deflation, economic conditions will worsen and, therefore, long-term U.S. government bond yields will decline. . . . But what happens to fiscal deficits and monetary policies under a scenario of a further decline in economic activity and a further collapse in asset prices? The answer is very simple. Deficits will increase further and more money will be printed. And the longer weakness in the economy prevails under the deflationary scenario, the more fiscal deficits will pile up and the more easy monetary policies will be pursued.

So, whereas near-term deflation is a distinct possibility, in the longer term inflation is more likely because of several factors. When the economy recovers (and the recovery is likely to be fragile), the Fed will be very reluctant to increase short-term rates. Another reason for the Fed's reluctance in this respect will be the size of the government debt, given that higher interest rates would increase the interest burden. Therefore, I can't imagine any scenario under which the Fed wouldn't keep interest rates at an artificially low level, as it also did post-2001. That such a monetary policy, combined with the growing fiscal deficits discussed above, is more likely to lead to inflation rather than deflation should be clear."

And here, in Marc's words, is what the funding crisis could look like:

"For the reasons I explained above, inflation will pick up. With or without Fed tightening, interest rates will shoot up because of a loss of confidence by foreign U.S. dollar debt holders and the dollar tanks. Government debt payments and health care expenditure will soar. Instead of contracting, fiscal deficits will increase and force the Fed to continue monetizing the debt at a time when it should be tightening. . . .

A vicious cycle of higher and higher inflation rates and a weaker and weaker dollar will follow amid economic weakness, because personal incomes will be squeezed by inflation. Eventually, hyperinflation will follow. So, in the debate about inflation and deflation, both camps could be right but at different times."

Marc is far more certain than I am that hyperinflation lies ahead. For me, it's way too early to have to make that determination, and it's not at all clear to me that that is our ultimate destination.

However, I am more certain than he is that the maximum deflationary pressures have passed. The policies of the Fed and other central banks are why I continue to advocate that folks own the currency with no central bank to screw it up: gold.

GEe, who knew?

Lastly, in the slap-on-the-wrist department, General Electric (GE, news, msgs) announced Aug. 4 that it had agreed to pay a $50 million fine to settle an accounting fraud complaint brought by the Securities and Exchange Commission. That followed news of the day before that Bank of America (BAC, news, msgs) had agreed to pay $33 million to settle a similar charge, regarding false statements that it made on the Merrill Lynch deal.

Were these attempts to just sweep problems under the rug? Many of us have thought that GE has been monkeying with its numbers for a long time in an attempt to win at the game of beat the number.

The modest fines imposed by the SEC make it look as though GE and Bank of America had done nothing more than tell little white lies -- which hardly instills confidence that the agency is serious about its role as enforcer of financial integrity.

Regretfully, this is what I've come to expect from the government. (If I were surprised, I'd be outraged.) What those in command do is rescue the "establishment" rather than punish them for wrongdoing. How else can you interpret giving GE the functional equivalent of a parking ticket in light of the fact that, according to Bloomberg:

"The company broke accounting rules four times in 2002 and 2003 to increase earnings or avoid reporting negative financial results, the Securities and Exchange Commission said in a lawsuit in federal court in Connecticut today. 'GE bent the accounting rules beyond the breaking point,' SEC Enforcement Director Robert Khuzami said in a statement. 'Overly aggressive accounting can distort a company's true financial condition and mislead investors.'"

If this is what the paper tiger SEC decided to charge GE with, who knows what creativity really took place? I'm sure financial scoundrels everywhere are laughing all the way to the bank."

The Bottom Line:

Both inflation and deflation will have their time in the sun but in the end, it looks like all roads lead to inflation.

Faber sees it pretty much like I do. The Fed will get more and more desperate as this crisis deepens, and they will be forced to monetize the debt out of fear that the economy will collapse if they don't.

The Fed does not have the will to let things fail. Sadly, we no longer have any leaders at the Fed that have the character and strength to make the tough decisions.

The Fed/Treasury is filled with nothing but a bunch spineless hacks that will do anything in their power to protect the financial elites in this country.

Thomas Jefferson, John Adams, and George Washington must be rolling over in their graves right now.

14 comments:

Anonymous said...

they rolled so many times in the past and will roll still many times in the future

getyourselfconnected said...

It is late, but what a great read jeff!
All my best
ED

Jeff said...

Anon

Yep

The future scares me a lot more then the present.

I am afraid to see what happens after spending trillions of dollars we don't have.

Jeff said...

Get

I liked this one as well. Fleck is one of my faves!

Anonymous said...

The recent fines for Bank of America and General Electric are just another example of the corrupted US government. Working together with their buddies in Wall Street, these elitists continue to rape and steal from the American people.

GE and BAC clearly misleaded and lied to their investors. Their criminal actions resulted in tremendous loss of money for the investors. Once the crime is uncovered, shouldn't there be criminal charges against the financial officers and executives? Shouldn't they be fined out of their pockets? But instead, the shareholders of the respective companies have to pay. Talking about getting raped and coming back for the 2nd act.

What a sicked country we live in!

Herb said...

Isn't sugar one of the most tightly controlled of commodities and have one of the highest tariffs?

I think deflation is still the major force in the economy right now.

Jeff said...

Anon

Totally agree!

I thought that part of the article was as important as Faber's comments.

The taxpayer is being totally assraped repeatedly!

I have never been so frustrated in my life as I watch how this all plays out.

I feel your pain.

Jeff said...

Herb

Thanks. Didn't realize how sugar was regulated.

Deflation is a powerful force for now as Faber said. If it's so tightly regulated then why is it at a 26 year high?

This feeds the inflation thesis if its so tightly regulated.

The falling dollar has so many ramifications.

Fleckie makes a great point here.

Herb said...

The USDA under the direction of the Secretary of Agriculture tweaks tariffs in response to consumer demand, very similar to how Soviet planning boards used to do. :-)

This allows US sugar prices to be somewhere between 10 and 20x's what other countries pay and allows the sugar industry to make extra money

If you are bored, you can read the USDA press releases here: http://www.fas.usda.gov/itp/imports/Sugar/sugartrqpress.asp

Anonymous said...

There might be a third option. A new system? The leaders should be aware that growth is not a solution much longer anyway.

Jeff said...

Herb

Thanks for the link. Not surprised by that. Most "special interests" are taken care of in this country via lobbying:)

Anon

I keep coming back to that thought as well.

Do we just need a reset and start over with a new system?

I wish I had the answer. The solution in my eyes is a devestating deflationary "reset" where prices are in line with incomes.

Unfortunately, I don't think that the government is heading in this direction. The oligarchs are too obsessed with saving themselves.

I am afraid that we will blow their heads off in the process of doing so.

Peter said...

Very good read, thanks Jeff.

I am most agreement with your comment about our Founding Fathers. None of this would have passed the smell test. Peter Schiff said in one of his video blogs that if the Founding Fathers knew what our taxes would be like today they would have never revolted.

Did you see Pollock's video series about the Great Reset? His premise is that the systemic collapse of our system has already occurred and people are ignorant of it and then there are those which will do whatever they can to try to save it. link

This cabal that runs our lives needs to collapse soon. The way the left wing is treating the people who come out to protest the health care reform is a joke. I think these progressives want to vote to disband the citizens and find new ones. Now they are sending out their union (SEIU) thugs to intimidate and beat up people.

We could change this very easily if we made took away voting rights from anyone who receives any form of government benefit they did not pay for, welfare, food stamps, medicaid. How come it is illegal for me to give you $1,000 to vote for you but it is legal for me to promise to steal $10,000 from someone else and give it to you if you vote for me.

Jeff said...

Peter

No problem.

Thanks for the link.

Thats was an interesting series by Pollock.

Systemic change seems to be the new buzzword floating around out there.

Its going to be interesting to see how this all plays out.

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