Inflation
Economy Watch: Dichotomy of Reflation vs. Deflation
As the debate of inflation or deflation currently taking the center stage of financial professionals attention, here I put together a collection of comments from various authors on this debate:
Jeff Nielson commented on Seeking Alpha on May 25th:
All these talking-heads continue to act like inflation and deflation are purely “either/or” scenarios. Not true.We will see continued deflation in asset classes which are grossly over-supplied (i.e. U.S. dollars, U.S. financial products – including bonds, and U.S. real estate).
On the other side of the fence, there are the asset classes in short supply: commodities – and especially gold and silver.
Precious metals should be the CORE of any/every portfolio, not merely some ancillary hedge for people who really have no clue about what is going on.
Economist Menzie Chinn commented in his article on June 1st:
Of course, the United States in 2009 is different than Japan in 2001. One key difference is that Japan was, and remains, a net creditor. America is a big net debtor to the rest of the world, with extremely large holdings of US Treasurys by foreign private and state actors. And so, for me, I worry more about higher real interest rates (portfolio balance effects) than higher inflation. But even here, real yields according to TIPS seems fairly low in historical perspective (and roughly comparable to those prevailing during the period characterized as “the saving glut”).
J Clinton Hill stated in his article on June 5th:
That’s all for Thursday’s economic data and related news events. I will buy the notion of economic recovery when the issuance of government debt begins to show signs of contraction or deceleration. Thursday’s data underscores the tug of war between the deflationary forces of economic weakness and the inflationary monetary policies of the Fed. Although the game is still on, the scoreboard (i.e. bond market) indicates that the Fed is scoring points and determined to make history as one of the greatest comebacks of all time
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Chart Reading: USD Chart Analysis
US Dollar (3/26/2009)
S&P 500 (3/26/2009)
Spot Crude Oil (3/26/2009)
Strong US dollar seem to be correlated perfectly with poor stock market, crude oil prices. In a way that it’s almost perfect timing that US dollar peaked on the day in early March when S&P 500 hit an 12 year low and reversed track. It’s almost on the same day when crude price started to break out for real, it tried to break out several times in last 3 months, but turned back at resistance line.
It’s not illogical for this relationship: if the real production is not increased significantly, the only way to make people rich is to print out more paper money, and each unit of paper money has to depreciate more to sustain the “wealth making”, “crisis prevention”, “bail-out”, whatever you call it.
One thing is for sure, when USD starts to depreciate, and especially when government is behind this trend, it’s time to spend your cash to buy some stocks, gold, energy. For investors in stocks, this is great, let’s hope USD to depreciate more.
4/24/2009 Update:
US Dollar (4/24/2009)
S&P 500 (4/24/2009)
Spot Crude Oil (4/24/2009)
The S&P is now going thru the right shoulder of reverse head and shoulder bottoming process, and USD is doing the right shoulder before the huge crash which I estimate to start around July. So the chart indicates there will be still an small up-leg left for USD.
Even though there is a rough relationship between $USD and equity, commodity prices, what’s most interesting was the relevance between these market forces changed over time. Let’s take a look back at history:
From mid July to early September, $USD started to rally, in the mean time, stock market started to look like about to fall off cliff. Crude oil started to drop from historical high of $147. This is the prelude of the huge crash. During this time, only dollar-oil relationship worked.
From early to late September, $USD pulled back, in the mean time, stock market didn’t respond to that pullback, Crude oil did. This time, only dollar-oil relationship worked.
From late September to mid October, $USD resumed its rally, this time with stronger force than last time, reflecting the real crash had begun, we all know what happens to stock market and crude oil. During this time, both dollar-stock and dollar-oil relationships worked.
From mid October to mid November, $USD continued its rally, but with weaker force, stock market mirrored that movement, but crude oil continued its free fall. During this time, I would say both relationships worked, but dollar-stock seemed to dance better than dollar-oil.
From mid November to mid December, $USD crashed due to Fed’s dropping rate to 0, stock market responded, cruded oil kept dropping despite a small rebound in early December. During this time, dollar-stock relationship is again bettern than dollar-oil.
From mid December to early March, $USD staged a strong come back, this time rallied higher than the peak reached in November, stock market responded, crude oil didn’t, instead, crude oil reached its bottom exactly when $USD started this round of rally. Remember at this time, Shanghai stock index started to rebound. So shall we say this time, crude oil wishes more to dance with Chinese stock index than with US Dollar?
From early March to mid March, $USD crashed again due to Fed’s decision to print more money to buy T-bond and MBS, stock market responded, crude oil responded as well. During this time, dollar-stock and dollar-oil both worked again. Last time, both relationships worked was late September to mid October.
From mid March to now, $USD rebounded with a wedge shape (a precursor to huge crash), stock market shrugged it off, continued its rebound to the heavy resistance of 870, while crude oil traded sideways. During this time, let’s say both stock market and crude oil are getting ready for the huge crash of dollar.
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Economy Outlook: Will Monetary Policy Cause Inflation? Timing is Key
Since the outset of economic crisis in 2007, Federal reserve has taken expansionary monetary policy to prevent the economy from falling, the result was a more than 2 folds expansion of Fed’s balance sheet in 2 years from 897B USD by early 2007 to 2013B by early 2009.
With the March 18th FOMC decision, the Fed’s balance sheet is expected to expand further to 3018B by September 2009. The Fed decided on Mar. 18th to expand balance sheet by an additional 1.05T (750B MBS, 100B agency debt, and 300B long term Treasury securities) in next 6 months.
The question is: will this extraordinary measure of increasing monetary base cause inflation? The answer is definitely yes. Even Bernanke himself acknowledged that although the short term assets such as commercial paper, currency swap can be disposed quickly, there are a big portion of long term assets such MBS, T-bonds in Fed’s portfolio that can not be disposed quickly, Fed’s holding of these assets will delay the speed of shrinking monetary base.
The table below shows the assets of Fed’s Balance Sheet (before 1.05T expansion impact),
The table below shows liabilities of Fed’s Balance Sheet before 1.05T additional expansion. The majority of the increase are held as banks’ excess reserves due to bank’s extraordinary concerns to take any risk other than reserving cash with Fed. The bank’s current decision of not distributing these 790B additional cash to the general public is the reason why inflation hasn’t gained its force yet.
However, how much excessive reserve banks decide to put into Fed depends on the general economic condition, when the economy improves, banks will take more risk by lending out more money than now, then the currency available to public will expand, that will cause inflation. So the key to tame inflation is for Fed to shrink the monetary base at a speed that banks decides to lend out more so that currency available to public remains relatively constant.
If this is not achievable, then the how much faster banks will reallocate current reserve cash to the public than Fed shrink’s balance sheet will be how severe the inflation will be.
Source:
More Money: Understanding Recent Changes in Monetary Base
William T. Gavin
The Crisis and Policy Response
Ben Bernanke
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Inflation and Commodity Price: CRB Indices Explained
One way to gauge inflation is to watch commodity prices. CRB index is considered the “S&P 500″ of commodity prices. However, CRB index does not come with one index only, it comes with a series of indices, in at least three groups, what are the differences among them? Let me try to explain here:
CRB Spot Indices
This is the oldest group of indices among the CRB index family, since it started to calculate in 1934 right after Great Depression.
In the 30 years since 1972 to 2006, the index channeled between 200 and 300. The 2008 movement to 400’s level reflects global crisis and recent returning to 300’s level reflects crisis ending is near.
Details about CRB spot indices
Continuous Commodity Indices (CCI)
In contrast to CRB spot indices which shows spot prices of commodities, CCI reflects the commodity futures prices.
The chart of this index shows very flat price before 1972 which reflects great price stability under Bretton Woods system. Right after Nixon abandoned the Bretton Woods system in 1972, the index moved up and never went back to 100 level.
Details about CCI
Reuters/Jefferies – CRB Indices (RJCRB)
Before 2006, the chart shows this index is almost identical to CCI, its composition was changed in 2006 to include crude oil and gold in calculation, while CCI obviously didn’t include crude oil until now.
Details about RJCRB
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