Straight Talk with Mike Shedlock (aka "Mish")
Today marks the launch of our new and (hopefully) regularly recurring "Straight Talk" series, featuring thinking from notable minds the PeakProsperity.com audience has indicated it wants to learn more about. Readers submit the questions they want addressed and our guests take their best crack at answering. Our hopes are high you'll enjoy the expert insights and alternative perspectives this new series brings.
Our inaugural Straight Talk contributor is Mike Shedlock, author of Mish's Global Economic Trend Analysis, one of the most visited and respected economic blogs on the Web. Mish is an outspoken deflationist and outlines his rationale for being so in his answers to our questions. He is also a registered investment advisor representative for SitkaPacific Capital Management.
1. You’ve gone from mainframe computer programming analyst (in 2005) to being one of the most widely-read econobloggers in the world today. To what extent do you attribute your competitive advantage to holding a non-traditional background vs. the more ‘classically’ trained analysts and commentators?
Mish: It certainly helps not having a background in economics as taught by academia today. Nearly everyone in academia is a Keynesian or Monetarist.
It is safe to say that Krugman is the high priest of the Keynesians. In current academia, Greg Mankiw is arguably the high priest of the Monetarists. If we include the Fed, then the Monetarist high priest is without a doubt Ben Bernanke, whose background just happens to be academia, as opposed to any real world experience.
I find it amusing to see the battles between the two camps when they are both wrong about their proposed solutions. The only thing they are ever right about is when they attack each other.
In contrast, I had some very good teachers with non-academic backgrounds in self-taught Austrian economics. One of them is a friend for going on 10 years. I refer to him on my blog by his initials "HB". He has done a couple guest blogs on my site under the name "Trotsky".
"HB" now has his own blog under yet another pen name, Pater Tenebrarum. The Blog is called Acting Man, with a perspective of Austrian economics.
I also need to thank Barry Ritholtz at the Big Picture Blog for early on promoting my work, Todd Harrison at Minyanville, and of course Calculated Risk who actually created the first template for my blog.
Interestingly, Barry, CR, and I have been 1-2-3 (in various orders) in terms of page counts according to Traffic Rankings for individual, non-corporate sponsored blogs.
Marc Faber has influenced me a lot and I consider his book Tomorrow's Gold to be required reading. Marc is also a friend even though we disagree on the inflation/deflation debate.
There are two other must-read books and the electronic versions come at the great deflationary price of zero.
Both of those are by Murray Rothbard, with thanks also to the Mises Institute for making them available at no cost.
In addition, I have certainly learned a lot from John Hussman who writes a great column every week, and more recently from David Rosenberg who writes a great column nearly every day.
Certainly Bloomberg is a great source of information and to pick a single Bloomberg author it would be Caroline Baum. Baum's mentor happens to be economist Paul Kasriel who also has taught me a lot. So has Australian economist Steve Keen.
Thanks go to an Austrian-minded friend who simply prefers to be known as "BC".
I also need to thank Krugman and others I violently disagree with. It helps clarify my thinking debating those I disagree with, even if they never respond.
Finally, I get a lot of interesting stories and commentary from my readers. Those readers are real people, doctors, business owners, scientists, and technology wizards, most of whom operate in the real world, and thus have more street smarts and common sense than anyone on the Fed.
Looking at my answer now that I have typed it out, my competitive edge is to do one hell of a lot of reading, thinking, and typing, day in and day out, even weekends. I entertain all points of view, even if it seems like I don't in my finished posts.
2. Many of our readers have subscribed to Chris' position that the economy must be increasingly interpreted through two other lenses; energy and other environmental resources. Can you comment on the Three E's?
Mish: I am a firm believer in peak oil. I don't know how anyone can deny it.
Given peak oil, and given the demand from China for oil and other commodities, the world is on a crash course of demand that cannot be filled.
China is growing at 8-10% a year (assuming you believe the stats). Can China keep growing at that rate forever? For even 10 more years? What about India? Brazil?
Either we get some serious energy breakthroughs, China slows, or the standard of living drops in the US, UK, and Europe. Well China does not want to slow, and the US and Europe are fighting hard to maintain a standard of living that is not sustainable.
Historically these situations end up with war. That is an observation, not a prediction.
Something has to give, perhaps many things, but all of the people who think China will soon be the number one economy in the world and that China's growth is sustainable, better start thinking about the implications of what I just typed above.
3. You’re a vocal deflationist. What do you see as the most convincing data points (the top 1-3) for your position and why?
Mish: Before we can discuss inflation and deflation it is imperative to define the terms. Not everyone will agree with my definitions, not even those who claim to be followers of Austrian economic theory. Yet my definitions have a solid theoretical and practical foundation.
Inflation and Deflation Definitions
Inflation is an expansion of money and credit, with credit marked to market. Deflation is a contraction of money supply and credit with credit marked to market.
The "marked to market" bit is my own addition. I use it because it explains a lot of things that are happening. Indeed, the entire definition is predictive of things that will happen. For example, if credit contracts and there is demand to hold money, treasury rates are going to drop.
Contrast that with a definition that says rising prices constitute inflation. What will treasury rates do?
It was easy to see the housing bubble would collapse and in turn credit would plunge and writeoffs would soar. That was the basis for my prediction that interest rates across the entire yield curve would make all-time lows.
When I made that call, oil was near $140, and nearly everyone thought I was nuts. But it happened. Recently we made new lows in 2- and 5-year treasuries and credit continues to contract.
Bernanke and various Fed members talk about preventing deflation, but that talk is always in terms of the CPI.
However, it is impossible to measure prices of consumer goods accurately enough, housing prices are not in the CPI (I think they should be), but most importantly, we are in a fiat credit-based economy.
In a credit-based system, where credit dwarfs money supply, it is foolish to look at inflation through the myopic eyes of either prices or monetary inflation alone. Sure, the Fed can print, but if there is no demand for credit, what does $1T or even $10T of excess reserves do? The answer is nothing other than to make the Fed's exit problem down the road a nightmare.
Money Multiplier Theory is Wrong
It is important to understand that widely believed money multiplier theory (the Fed prints and the money makes its way into the economy 10 times over) is wrong.
The reality is credit expansion comes first, reserves come second. I discussed this at length, using some charts from Steve Keen, in Fiat World Mathematical Model
Yet, talk is all the rage "just wait till all those reserves come pouring into the economy, it will cause hyperinflation". I have to laugh because the thinking is ass backwards.
What Really Happened?
- Greenspan lowered interest rates fueling housing speculation and a credit bubble.
- The housing/credit bubble burst.
- Credit plunged as did credit marked to market.
- In the wake of plunging credit the Fed stepped in to provide reserves for banks.
- Consumer psychology changed and there is no demand for credit so it sits there as so called "excess reserves", earning slight interest for banks to help them cover losses still to come from foreclosures, credit card losses, and commercial real estate losses.
Looked at in this fashion there are not really excess reserves at all.
Please see Fictional Reserve Lending And The Myth Of Excess Reserves for further rebuttal to the notion that monetary printing will soon have the inflation genie flying out of the bottle.
Credit continued to contract in 2009 but the stock market soared. This happened because the corporate bond market freed up, which in turn gave a new lease on life to hundreds of corporation otherwise headed for bankruptcy.
In response, value of debt "marked to market" on the balance sheets of banks went from pennies on the dollar to full value. Credit did not expand but credit marked-to-market sure did, even if it is impossible to say precisely how much.
Thus my model suggests 2007 to February 2009 were periods of deflation, March 2009 to May 2010 were periods of inflation, and now we are likely back in deflation but it is hard to say given institutions do not mark assets to market. Extend and pretend is massive.
Looking ahead, my model suggests we go in and out of deflation for a number of years, just as Japan did, without the economy ever picking up any steam.
4. Your position has called for a deflation first but then a probable transition over to inflation at some point. We won’t hold you to this, but what triggers do you see for this shift and, again with great latitude, when might this happen?
Mish: With fiat currencies, the probability of inflation approaches 100% given a long enough timeframe. However, we need to fix numerous structural issues, write off enough bad debts, and get to the bottom in housing before there is a serious chance of sustained inflation.
I am not calling for consumer prices to collapse (except in unneeded junk), but that could conceivably happen. By the way, because energy and food prices have been sticky compared to housing, we hear the statement all the time, "we have inflation in things we need and deflation in things we want."
No we don't. The statement is inaccurate because it defines inflation in terms of prices. With a proper definition one does not have inflation and deflation at the same time.
Critical Player is Congress, Not the Fed
The longer the Fed and Congress fight deflation, the longer it will take to play out. It could take 2 years or 10. The attitude of the next Congress, and the Congress and President after that will be crucial.
I believe the next congress will throw around fewer stimuli than the current one. I could be wrong. But 2 years will not seal the fate. There will be a presidential election in another two years.
Will we get a Chris Christie or another Obama? That is an undecided factor very much in play.
The critical point of this discussion is everyone's misguided focus on the Fed. The Fed arguably has a role, but Congress is a far bigger player than the Fed in determining the length of the path we take.
Interestingly, Bernanke, a Monetarist, recently chastised Congress over budget issues. This likely has Krugman going bananas.
5. In your own or in others’ forecasts of how the future will play out, do you think that the difficult-to-predict Human Crowd Psychology factor is underrepresented? If so, what could be done to better incorporate it?
Mish: Few understand the deflationary impacts of the entire gamut of trends that is playing out, or the stress those trends place on families.
I discussed this recently in Inflation Targeting Proposal an Exercise in Blazing Stupidity; Fed Fools Itself
Demographic Pendulum in Motion
It is futile to fight changing social trends, but that has not stopped the Fed with reckless proposals on top of reckless proposals. Please see Inflation Targeting Proposal an Exercise in Blazing Stupidity; Fed Fools Itself for more details.
As I stated in June of 2008, we are now on the back side of peak consumption and Peak Credit. Regardless of what Bernanke of the Fed does, the demographic pendulum is in motion. There is no going back.
That the Fed cannot change attitudes is at the very heart of the deflation argument. Japan certainly tried and failed, Bernanke will fail as well.
The Fed can provide liquidity but it cannot not determine where it goes, or if it goes anywhere at all.
The important point here is the pendulum has just barely moved from peak risk taking to risk aversions. With that in mind, and given the Fed and Congressional propensity to fight a battle that cannot be won, it will be years before the pendulum gets to the other side.
I have not mentioned this before but the pendulum is actually asymmetric, at least in terms of time, not necessarily price or attitude.
We spend far more time in inflation and risk taking than deflation and risk avoidance. Moreover the cycle swing takes so long time wise from one end to the other, that by the time we get to peak risk taking, most do not even think deflation is possible.
Everyone thinks deflation is impossible, much the same way everyone thought housing prices would rise forever. There were wrong about housing and they are wrong about deflation.
6. How the heck do you find the time to write so much? Our members are amazed by the output on your blog and by the fact that they’ve received personal answers to questions they’ve emailed you.
Mish: I certainly love what I am doing. I also believe I am helping people. I have stacks of emails to prove that point, mainly in regards to getting people out of housing, out of the stock market on time, into gold, and not betting against treasuries.
To be sure, I get some hate mail, mostly in regards to my stance on public unions, but that volume is small compared to everything else. I can get as many as 300 emails a day, and I try to answer any pleas for help. I have spent as long as 2 hours answering calls for help, even when I cannot possibly get anything out of it.
If someone sends me a link to an article I use, they may only get a one word response of "thanks". If I get a question, I try to answer. I certainly appreciate when some thoughtful people send me a link or a comment and say "no response needed".
Many days I am reading and writing for 15 hours. I can spend 3 hours just answering emails from readers and clients. On weekends, in the summer, I can spend as little as 2-4 hours, but 3 minimum is more like it.
I am often laughing my head off over things I write. So I am having fun.
Bear in mind my role at Sitka Pacific is advisory, client services, and general manager type functions. Those are part of the 15 hours mentioned. I do not trade. Fortunately I have a fantastic partner who shares the same risk management and customer first attitudes. We have grown from about $15 million assets under management to about $75 million under management in the last few years.
That is small by Wall Street standards, but I expect to double or triple that in a few years, the right way, by putting client interests first.
7. Which assets do you see as being the being the ‘most hated by the most people’? Which are ‘most beloved’? In your opinion, are these perceptions well-deserved and if not, what opportunities do they represent?
Mish: Certainly US treasuries are universally despised. People were shorting 10 year notes at 4%. Yikes!
However, after this rally it is hard to be super-bullish on them now. Bullish yes, super-bullish, no. I would advise not shorting them.
I do not think the gold story is fully understood yet. It may not be hated, but it is not loved like technology or housing was. Thus I think more will come from gold but it will not necessarily be from here. We can easily have a sharp correction first.
The one thing not despised but universally ignored is Japanese equities. For a long-term hold perspective, I like Japan. Apathy is a great setup. Otherwise, there is precious little to like about anything.
This market, including corporate bonds, is way over-loved. Sentiment is extreme, and earnings expectations will not happen. The market can keep going up, but the risk-reward setup is horrendous.
8. If you knew that the purchasing power of your existing assets and income would disappear one year from today, what would you invest in during the coming year to prepare?
Mish: The question left out a critical aspect of "how" assets would "disappear". For example, equity and housing assets might crash because of deflation, or theoretically the dollar could fall to zero in hyperinflation. How one would best profit would be quite different.
In regards to hyperinflation, the odds are minuscule. First we need to define the term.
Hyperinflation is a complete loss of faith in currency. Some think this will happen out of the blue, others think the Fed will print and print and print. Let's look at a few examples.
In the case of Zimbabwe, a loss of faith in currency occurred before the printing occurred. The Weimar Republic is a different story.
In Zimbabwe, the Mugabe government initiated a "land reform" program intended to correct the inequitable land distribution created by colonial rule. Ultimately, Mugabe's attempt to bail out the poor at the expense of the wealthy is what triggered capital flight and loss of faith of the currency.
His reforms not only caused a flight of capital and human capital (the wealthy), they also led to sanctions by the US and Europe. In response, Mugabe turned on the printing presses but the loss of faith in the currency had already occurred.
In Weimar Germany, printing for war reparations kicked off hyperinflation.
War reparations were a political event. So was the invasion of Germany to enforce payment of those reparations.
Argentina based its currency on the US dollar, a political mistake. When Argentina could no longer hold the peg, its currency collapsed.
Hyperinflation is a Political Event
The commonality between Zimbabwe, Weimar, and Argentina is they are both political events. In Zimbabwe a political event triggered capital flight, in Weimar a political event started massive printing, and in Argentina everything collapsed when a foolish peg could not be sustained.
In each case, a collapse of faith in currency (hyperinflation) led governments to massive printing campaigns, not the other way around.
The US compares to Zimbabwe how?
The US compares to Argentina how?
Is anyone going to force the US into war reparations?
The idea that we are going to wake up one day and suddenly out of the blue face hyperinflation may be theoretically possible but it is extremely unlikely in practice.
Moreover, and it is important to keep coming back to this point, we are in credit-based system. The Fed is not going to cause hyperinflation by printing.
Besides, the Fed cannot give money away. And as I have pointed out, Bernanke is even chastising Congress about fiscal spending. The Fed would not give away money even if it could!
Sure, the Fed can provide liquidity, but it cannot force businesses or consumers to borrow. Yet people tell me the Fed will cause hyperinflation. It does not add up.
Congress can give money away, but the next Congress will look a lot different than this Congress. I discussed the political and some economic consequences of that reality in Obamacare Career Ending Votes; Republican Chance to Win Senate; Expect House Blowout; Stimulus Appetite Greatly Diminished
Here is one more point about hyperinflation. If the US dollar goes, every fiat currency on the planet will follow. The idea that hyperinflation will hit the US alone is preposterous. The Euro, the Yen, the Pound would all go up in flames at the same time.
The way to protect against that situation is to have gold. Holding gold also works against the other extreme, deflation, on the basis that gold is money.
Gold does not do well in all circumstances, however. Gold did very poorly from 1980 to 2000, a period of ordinary inflation. There is no guaranteed play anywhere.
9. What's the question we should have asked, but didn't? What's your answer?
Mish: I guess it would be: "Does your crystal ball have a forecast for the stock market? For Gold? The US Dollar?"
Let's start with gold. I see articles everyday by some prominent people saying things like "I know gold is going to ... whatever".
The thing is, they don't know and neither do I. Only a charlatan or a fool can make such a claim. Of course the fools and charlatans may be right, but it is not because they "know" anything.
One thing I do know is that I don't know things of that nature. That puts me ahead of all those who claim to know the unknowable.
I prefer to look at things in terms of probabilities. It is highly likely the Fed embarks on Quantitative Easing. That should be good for gold, but short term that QE may easily be priced in.
Moreover, the Fed may go slower than what the market thinks.
Thus, there could be a huge "sell the news" event in both gold and the stock market on the QE announcement, no matter what that announcement is.
Should that happen, given that gold is in a long-term bull market, and given that Bernanke will likely go back to the QE well, I expect buying the next big dip in gold would be a higher probability event than buying a 10% correction in the stock market.
There is a lot going for gold, but it is by no means a "sure thing".
Is the Equities Bottom In?
Many people claim the "Bottom is In"?
Is it? How can they know? I am not even sure if the bottom is likely in. Look at the half-dozen 50% or greater rallies in the Nikkei over the course of two decades, all taken back and then some.
How many "knew" that would not happen. How many in the US "knew" that housing prices could not possibly collapse.
I am quite sure that stocks are richly priced, but that sure does not mean stocks cannot rally further from here.
We are in a credit bust scenario with enormous deflationary pressures, even if outright deflation is not sustained. As such, the risk in equities is a lot higher than most think.
There is a lot of confidence in the Fed's ability to produce inflation. Indeed, I think there is a bubble of confidence in the Fed's ability to produce inflation.
Should that bubble burst, equities can collapse far faster than most think possible.
Hyperinflation is theoretically possible, but highly unlikely in practice for reasons stated above. But what if Prechter is right? Actually I think the grand-supercycle collapse he is calling for is also highly unlikely, although it too is certainly possible.
Is worry over such extremes or attempts to profit from such extremes at this stage a waste of energy? I think so.
Unless you are a day-trader, it is important to be aware of such possibilities, while focusing on the more likely probabilities.
The bottom may be in, but a test of 850 or even the 700-800 area of the S&P sure seems likely enough. How many are prepared for that?
Anti-dollar sentiment is once again extreme. It is quite similar to the extreme anti-Euro sentiment a few months back. Look at what happened. Are we setup for another reversal?
How many are prepared for the market to go sideways for 5 years or longer, as earnings catch up with valuations. This happened in the 70's and there is absolutely no reason it cannot happen again.
Sadly, most aren't prepared for those scenarios, just as they were unprepared for the collapse we saw in housing and the collapse we saw in global equities.
Some questions to ponder are: Do you really want to be long after this runup? How long? What are appropriate hedges? What happens if the dollar rises? Is it possible, if not likely to get a reasonably strong move up in the US dollar here?
The important point is not whether or not you agree with my probabilities; the key point is to be thinking about risk management and opportunities. It is far easier to make up for lost opportunities than lost cash.
If you have not yet seen the other articles in this series, you can find them here:
- Straight Talk with G. Edward Griffin: What's Coming Next Isn't Pretty - 11.29.10
- Straight Talk with James Howard Kunstler: The World is Going to Get Rounder and Bigger Again- 11.17.10
- Straight Talk with Steve Keen: It's All About the Debt - 11.09.10
- Straight Talk with Mike Shedlock (aka "Mish") - 10.26.10
CM.com readers can submit their preferences for future Straight Talk participants, as well as questions to ask them, in our new Straight Talk forum.