Mish analyzes Chris’s “One Hand Clapping Theory”
Mish has written a blog post analyzing Chris’s recent “The Sound of One Hand Clapping: What Deflationists May Be Missing” article. I’m not advocating one side or the other here (I think both of them make good points). Just enjoying the discussion/debate. Here’s an excerpt – click on the link in the first sentence for the entire article.
Numerous people have asked me to comment on Chris Martenson’s article The Sound of One Hand Clapping – What Deflationists May Be Missing.
The hot topic of the day is “Inflation or Deflation?” and the camps are firmly divided into groups of inflationistas and deflationistas. When asked which camp I am in, I reply “Yes.” Some would say that puts me in the confusionista camp, but I actually have an explanation for why are living in a world encompassing both.
From a technical perspective, we are absolutely in one of the most powerfully deflationary periods in history, yet, besides housing prices and a few over-produced consumer goods, we find that stocks, bonds, and commodities are all well-bid at the moment.
While we can ascribe some of this to the artificial wall of liquidity (come to think of it, is there any other kind?) currently being thrown into the financial market(s) by the Fed, it leaves hanging the question of why that money is not being completely swallowed into the bottomless black hole that the deflationist camp says lies at the heart of our current financial system.
And they are right; there is a black hole at the center. If we treat the credit doubling that occurred between 2000 and 2008 (from $26 to $52 trillion) as a normal bubble that will follow the same pattern of decline as numerous historical bubbles, then we might reasonably predict that some $26 trillion of debt will somehow “go away” over the next 6 years. This is indeed a massive black hole.
Mish: So far so good. No one should argue with the idea that we are in the “one of the most powerfully deflationary periods in history“. However, many do so anyway, typically based on faulty definitions of inflation and deflation.
The pertinent question now is: does one judge a deflationary period by what stocks and corporate bonds are doing “at the moment“?
Let’s take a look at things in an appropriate timeframe.
Please consider some excerpts from Creative Destruction
Two Lost Decades
The Japanese Stock Market is about 25% of what it was close to 20 years ago! Yes, I know, the US is not Japan, that deflation can’t happen here, etc, etc. Of course deflation did happen here, so the question now is how long it lasts.
The five month, 50% rebound in the S&P 500 was certainly spectacular. However, the more important question is where to from here?
Take a look at Japan’s “Two Lost Decades” for clues.
Creative destruction in conjunction with global wage arbitrage, changing demographics, downsizing boomers fearing retirement, changing social attitudes towards debt in every economic age group, and massive debt leverage is an extremely powerful set of forces.
Bear in mind, that set of forces will not play out over days, weeks, or months. A Schumpeterian Depression will take years, perhaps even decades to play out.
The chart shows that over the last two decades, Japan had four rallies of 50% or greater, yet two decades later the Nikkei is 75% off its peak.
Is it impossible for that to happen here?
Mish seems to find CM’s argument to be solid with the caveat that it’s not possible for the gov to let the banks ignore their bad assets forever (just by suspending the mark-to-market rule indefinitely) — that eventually the markets will factor all that in.
But if the markets are being manipulated (in part by the entities holding the bad assets)…? What’s to stop them? Foreign central banks deciding they have enough dollars/US bonds? American average-folk investors getting a clue/seeing through the charade and bailing out of the markets? (stop snickering — it could happen! [wry grin])
Seems to me that no matter how malleable “reality” is made to be by TPTB, eventually the Wile E. Coyote moment arrives and the inevitable plunge is on. Key thing then is to be decoupled (to the extent possible) from W.E.C. as he plummets…
Thanks to Dr. Chris and Mish for the analysis. Excellent stuff!
Viva — Sager
My take on Dr. M’s post was that he was looking for a reason that the stock market keeps rising despite the deflationary black hole that is eating our economy. I would suggest there is a simpler answer to that question: The dumb money is extremely bearish right now. I no longer subscribe to my market sentiment service, so I was unaware of the dumb money’s position until I just read this:
From “thetechnicaltake” at ZeroHedge:
Figure 1. “Dumb Money” Indicator/ weekly
The “Smart Money” indicator is shown in figure 2. The “smart money” indicator is a composite of the following data: 1) public to specialist short ratio; 2) specialist short to total short ratio; 3) SP100 option traders. The “smart money” is neutral.
Figure 4. Rydex Bullish and Leveraged v. Bearish and Leveraged/ daily
This explains why the market continues to rise despite horrible fundamentals. The coming crash will serve to enrich the smart money, not the dumb money. With this level of bearishness by the worst market timers, I don’t see a potential for a significant decline until Christmas at the very earliest, more likely the early spring of 2010. Despite what the author of the above post believes, I am bullish for the next couple months on the stock market.
And Ilargi over at TAE has also chimed in basically agreeing with Mish and Nate’s critique, that the banks and the government cannot keep bad assets on their books with no ill effects for much longer.
Also, here is something from Stoneleigh posted in the TAE comments a couple of weeks ago. She concurs with Chris’ point on the necessity for confidence, but she describes it in terms of the impending end of the stock market rally and the limits of the Fed:
The Fed is not omnipotent, especially in comparison to the weight of the collective that will be ranged against it once the market turns. If it were possible to print one’s way out of trouble then we would never have seen periods of deflation historically. No one can print confidence. All they can do is to play confidence games temporarily – promising to stand behind everything, knowing perfectly well that it’s a promise they coud not keep. They hope that by making it, they will not have to keep it, but the market is very good at calling desperate bluffs like that.
The market will turn when confidence does, and I believe that will be soon. As I have said before, this will not lead to an imminent bond market dislocation. First I would expect a flight to safety and record low nominal interest rates. IMO a bond market dislocation, where rates shoot up into the double digits, is perhaps a year away, at an initial guess. When it happens it will be because everyone will be trying to borrow (this being a global crisis) and few of the very small number of parties still able to lend will wish to do so, due to tremendous (and entirely understandable) risk aversion.
The global economy is not a machine that can be directed with appropriate levers. It is a messy, subjective and thoroughly irrational human construct. Crowd psychology is the most important element to understand in predicting what it will do next.
IMO we will see the Fed revealed as essentially powerless (as the little man behind the curtain) as the next leg of this crisis unfolds. It was never a public service duty bound to trash its own balance sheet for the supposed wider benefit, although it has done so to some extent. IT has limits, and we are going to see them soon enough.
As mentioned above, TAE are predicting an imminent end to the stock market rally, followed by a “flight to safety.” Stoneleigh again:
As stocks fall, we should see the US dollar rise, the Canadian dollar and the Euro fall, gold and silver fall, and oil fall. We should see nominal interest rates fall to record lows (perhaps even moderately negative nominal rates), although the on-going collapse of credit will mean high interest rates in real terms, so that the central bankers will still be ‘pushing on a string’. As bond yields fall, prices should rise.
A bond market dislocation (where interest rates spike up and government spending is slashed to the bone) comes further down the line.
The bond market will prevent printing. Debt junkie economies are dependent on access to international debt financing, and that will not be available to nations that print. There will be far more nations trying to borrow than willing to lend, and that is a recipe for much higher rates (once the initial panic, flight to safety and record low rates are over).
All the Fed is doing is adding to the huge number of excess claims created by the credit hyper-expansion. The underlying real wealth pie is still the same size, but more and more mutually exclusive claims are being produced, and these surplus claims are destined to be extinguished en masse in a deflationary collapse.
The Fed is granting these additional excess claims to the very people who were instrumental in causing the problem in the first place, and who are in the best position to know that claims to real wealth will only be worth anything if they are cashed in before the herd tries to cash in. Essentially, the claims of the public are being actively subverted to an even greater extent, as by the time they try to cash out there will be nothing left. The little guy never gets an even break.
We will eventually see a default. It is simply inevitable. You just can’t keep kicking the can down the road indefinitely. However, just because a default is inevitable does not mean it is imminent. A flight to safety is a knee-jerk reaction to threat. It is not a rational response and does not look at the reality of the dollar’s position. A rush to the dollar is something people will do on an emotional imperative, and it will push up the value of the dollar substantially. Betting on a dollar carry trade is therefore a sucker play – evidence of an imminent dollar bottom in fact.. . . . .The dollar should first rise and then collapse in value. I would expect the rising phase to last perhaps a year. When the collapse happens it will probably coincide with the coming bond market dislocation. However, the value of the dollar relative to other curencies will be much less important in practice than the value of cash in relation to available goods and services domestically.
The anger and recrimination that are coming this time will be something almost none of us have any experience with, and it will be terribly easy to be caught up in it. Don’t do it, as that kind of vengeful and punitive mindset will drain energy and resources from what you need to do to help yourself and your loved ones. Ultimately it fractures the trust that holds society together at a time when cohesiveness matters most. While this is inevitable at a national scale, it need not be at a very local level where a few individuals can make a difference.
Thanks for posting that piece. Actually, the only two blogs I follow consistently these days are Chris’s and TAE. I’m finding my need for information is less than it used to be, but what I particularly appreciate is perspective, insight and analysis. Chris and Ilgari and Stoneleigh provide that as well or better than anyone I’m aware of.
Quick logistical question: do you use RSS to follow TAE? I cannot get the feed to work properly. I’ve contacted them about it but never received a response.
switters, JAG and funkyspec… Thank you for posting the responses.
Thank you for compiling Stoneleigh’s thoughts for us here. They resound much more with my personal perspective than Dr. M’s , or even Mish’s, do.
Perhaps I need to be spending much more time at TAE than here.
Thanks for posting! This is not the first time an article from Stoneleigh resonates with me. I’ll have to follow TAE more closely.
Thank you for dissecting all of the responses in your post above, very helpful.
I am a little confused by the tone of the TAE folks as it seems, well, somehow hostile or maybe even angry. If that’s the case, if my attempts to explain the current market behaviors we are seeing has made Stoneleigh and Ilargi mad somehow, then I would say that they are possibly operating from a place of belief. Whenever an analysis or set of statements result in someone reacting angrily, it usually means beliefs are in play.
Which can be fine, we all hold beliefs, but I have found, through the school of hard knocks that holding beliefs about markets can be a dangerous thing.
So one thing that I am extremely cautious about these days is to take careful note when I read or hear something that stirs my emotions because it means that my beliefs are in play.
I am not at all wed to either the deflation or the inflation argument either way. I merely will note that bad loans have been effectively hidden for over a year and that this has allowed the markets to recently behave in ways that those wedded to the deflationist argument (‘belief’?) did not and would not have predicted.
At this point I cannot say when, or even if, there is any sort of hard or predictable end-point to the scam that allows losses to be hidden in plain view. I also thoroughly disagree with the notion that the Fed “cannot” eat these losses forever. If our foreign friends will not call our bluff, and they haven’t for decades, then there’s absolutely nothing that will prevent the Fed from continuing to expand its balance sheet.
I mean, it’s all fictitious anyway – it’s not like physics are involved, just electrons.
For example, if the Fed is holding a $1 billion MBS that is on its balance sheet that they hold to maturity and it expires worthless what actually happens? Let’s find out:
A) Fed balance sheet = $2,000 billion
B) $1 billion MBS expires worthless
C) Fed balance sheet = $1,999 billion
What has happened? The Fed’s balance sheet shrank by a billion. So what? As far as I can tell the answer is “nothing”. The next H4.1 report will show a number on a poorly formatted HTML page that is slightly different than the prior release.
And if the Fed wished to expand its balance sheet back up to $2,000 billion? That’s easy, it just prints up another billion out of thin air and it’s done. Not to put too fine a point on it, but how is it possible for an entity to take a loss on an asset denominated in it’s own obligation? That would be like me taking a loss on a debt someone owed me in “Chris Bucks.”
While I am in violent agreement with TAE about most everything, I lack their certainty that what “should” happen is what will happen. What should happen is a massive debt default/reset event. What will happen might be that or it might be something else (like a direct transit to a currency crisis, or inflation, or ….?).
And here’s where my personal belief comes into play – certainty is not as important as flexibility in today’s environment. This is why I continue to advise holding both gold/silver and cash. It is my opinion that our monetary authorities will fight deflation tooth and nail and that they have not yet exhausted their policy actions. Further, I believe we have another business cycle or two in front of us.
The data, as I am dispassionately reading it right now, says that there is a wall of liquidity in the markets – we see it in stock, bond, and commodity prices. We’ve seen a return to risk tolerance (and even preference).
But the views held by the TAE do not anger me, I hold out the entirely possible view that they may be right in terms of both direction and timing. I enjoy their incisive thinking and value the opportunity to stretch my thinking and test where I may be holding limiting beliefs (of which I am sometimes unaware until confronted by them).
I will however, note that their statements that I am “dramatically wrong” and that “Martenson is better at gathering data than analyzing it” are indications that somebody’s feathers might have been rubbed the wrong way and that beliefs might be in play.
To quote from your parts above, I only had to read one sentence deep to find a belief.
The Fed is not omnipotent, especially in comparison to the weight of the collective that will be ranged against it once the market turns. If it were possible to print one’s way out of trouble then we would never have seen periods of deflation historically.
Here the belief is that something called ‘the market’ is bigger than the Fed. But to dissect it a bit, for the past year the Fed has been the entire market for government paper (as per the CFR report I posted a while back). So we have to admit that for an entire year the Fed has been bigger than the market. Why not two years? Did anybody predict (especially deflationists) a year ago that the Fed could do this for a full year? I know I was surprised. Are these not important and relevant considerations as we try and navigate our way through this mess?
Of course they are. I happen to know people who have lost their shirts trying to trade on the basis of what should be happening. Instead, I have found great success by simply observing what is happening and then trying to make sense of it all.
And let me dissect the second sentence as it is also a statement of “fact” that is actually not well grounded in history. We’ve been under a pure fiat standard globally since 1971 and in that time there has never been a sustained period of global deflation. Bouts of deflation are historically extremely rare and are badly outnumbered by periods of inflation and hyperinflation (even under hard money standards).
So I find it puzzling (if not dangerous) to try and compare today to “then” because the currency systems are entirely different. When your monetary authority can zip a billion dollars into every bank account in the country in the next three minutes (should it decide to do that), then you have to remain open to the possibility that things might just play out in new and creative ways this time.
And that’s my main point, I simply lack the certainty over both direction and timing that is on display at TAE and while some may find such conviction comforting, I cannot bring myself to share it.
The funny part about all this is that except for divergences on mechanisms and timing, our advice is nearly indistinguishable and so I gladly and happily concede that there might well be multiple analytical frameworks that converge on the same conclusions.
Thank you for the opportunity to continue the discussion.
For the record, Ilgari took some flack for his remarks in the comments section of his post and Stoneleigh made it clear that she didn’t endorse what he said. I also couldn’t resist writing this in the comments section there:
think Chris Martenson’s position has been unfairly characterized by Ilgari. Chris does lean towards inflation, but he also clearly says we’re in deflation now and may continue to be for the next couple of years.
One thing I really appreciate about Chris is his willingness to admit that he doesn’t have a crystal ball and can’t predict the future with 100% certainty. He’s far less dogmatic than many other folks who write about these topics, and he tries to keep an open mind.
I also completely disagree with the notion that Chris is better at gathering data than interpreting it. Quite the contrary, in my opinion. I, and many others around the world, have found his Crash Course and other writings to be insightful and informative.
While I might disagree with Chris on the inflation/deflation subject, as a long-time reader of TAE and Chris Martenson, I can tell you that you are closer than you care to admit on many other topics. I consider TAE and CM the only bloggers who really understand all three of the Three Es, and the inexorable connections between them. Both Stoneleigh and Chris M. emphasize the importance of behavioral dynamics in talking about this stuff. And if you look at Chris M’s recommendations for preparing for this crisis, and compare them with TAE’s, they are nearly identical.