Stoneleigh: There are many things we have discussed here frequently that come up as questions in the comments because we are attracting new readers all the time. I thought it would be a good time to answer those questions en masse, so that there would be a URL to point to if the same questions should come up again.
The basic point is that we here at TAE are expecting deflation. Although inflation and deflation are commonly thought of as descriptions of rising or falling prices, this is not the case. Inflation and deflation are monetary phenomena. The terms represent either an increase or a decrease, respectively, in the supply of money and credit relative to available goods and services. Rising prices are often a lagging indicator of an increase in the effective money supply, as falling prices are of a decrease. There is an important distinction to be made between nominal prices and real prices, however. Nominal prices can be misleading as they are not adjusted for changes in the money supply and so do not reflect affordability. Real prices, which are so adjusted, are a far more important measure.
Nominal prices typically rise during inflationary times as there is more money available to support higher prices, but prices need not rise evenly, and some prices may fall, depending on other factors. In real terms the picture would be quite different, as increases would be smaller and decreases would larger. When nominal prices fall despite inflation, it means that the price in real terms is plummeting. For instance, global wage arbitrage allowed the price of imported goods to fall drastically in real terms. In deflationary times, nominal prices typically fall across the board, but prices need not fall in real terms, and, in cases of scarcity, may well rise.
The easy availability of cheap credit has conveyed a considerable amount of price support - price support that will be progressively withdrawn as credit tightens. Prices will fall, but the collapse of credit will cause purchasing power to fall faster than price, leading to the apparent paradox of nominally cheaper goods being less affordable in the future than nominally more expensive goods are today. Moreover, there are likely to be substantial changes in relative prices between essentials and non-essentials. As a much larger percentage of a much smaller money supply will be chasing essentials such as food and energy, there will be relative price support for those items. In other words, while everything is becoming less affordable due to the collapse of purchasing power, essentials such a food and energy will be the least affordable of all, whatever the nominal price. People commonly speak of unaffordable prices as a result of inflation, but do not realize that deflation can have the same effect, only much more abruptly.
Thanks to a credit boom that dates back to at least the early 1980s, and which accelerated rapidly after the millennium, the vast majority of the effective money supply is credit. A credit boom can mimic currency inflation in important ways, as credit acts as a money equivalent during the expansion phase. There are, however, important differences. Whereas currency inflation divides the real wealth pie into smaller and smaller pieces, devaluing each one in a form of forced loss sharing, credit expansion creates multiple and mutually exclusive claims to the same pieces of pie. This generates the appearance of a substantial increase in real wealth through leverage, but is an illusion.
The apparent wealth is virtual, and once expansion morphs into contraction, the excess claims are rapidly extinguished in a chaotic real wealth grab. It is this prospect that we are currently facing today, as credit destruction is already well underway, and the destruction of credit is hugely deflationary. As money is the lubricant in the economic engine, a shortage will cause that engine to seize up, as happened in the 1930s. An important point to remember is that demand is not what people want, it is what they are ready, willing and able to pay for. The fall in aggregate demand that characterizes a depression reflects a lack of purchasing power, not a lack of want. With very little money and no access to credit, people can starve amid plenty.
Attempts by governments and central bankers to reinflate the money supply are doomed to fail as debt monetization cannot keep pace with credit destruction, and liquidity injected into the system is being hoarded by nervous banks rather than being used to initiate new lending, as was the stated intent of the various bailout schemes. Bailouts only ever benefit a few insiders. Available credit is already being squeezed across the board, although we are still far closer to the beginning of the contraction than the end of it. Further attempts at reinflation may eventually cause a crisis of confidence among international lenders, which could lead to a serious dislocation in the treasury bond market at some point. If a debt-junkie economy can no longer easily raise funds, then interest rates would rise substantially and spending at home would be drastically cut. This would be the financial equivalent of hitting the 'emergency stop' button on the economy, as it would cause a far larger rash of defaults than anything we have seen so far. We are not there yet though. Currently the dollar is benefiting from an international flight to safety, and it will probably continue to do so for some time, despite temporary counter-trend pullbacks from time to time.
We have seen a pattern of ebb and flow of market liquidity since February 2007, when the credit crisis arguably began. A constellation of market trends has largely moved in synch with liquidity. As liquidity falls, equities fall, bond yields fall (and prices rise), commodities fall, precious metals fall, real estate falls and the dollar rises, as cash becomes king. When we see market rallies, in contrast, rallies in bond yields, commodities, and metals are also common, and the dollar experiences a pullback. We appear to be beginning a market rally at the moment, which should lead to precisely this set of trend reversals. Such a rally is only temporary relief however. It may last for a couple of months, but then the decline should resume with a vengeance.
We have a very long way to fall, and the deleveraging process is likely to play out over several years. During this time we can expect to be mired in a worse depression than the 1930s, as the excesses that led to our current situation are far worse by every measure than were those of the Roaring Twenties. Unfortunately, we are much less prepared to face such an occurrence than were our grandparents. Our expectations are far higher, our knowledge and skill base is much less appropriate, we are far less self-sufficient and we have a structural dependency on cheap energy. This will be a very painful time. Deflation and depression are mutually reinforcing, leading to a vicious circle of decline that is very difficult to escape. It will be over when the (small amount of) remaining debt is acceptably collateralized to the (few) remaining creditors. At that point trust will begin to rebuild.
For a longer and more detailed explanation of the credit bubble and deflation see The Resurgence of Risk - A Primer on the Develop(ed) Credit Crunch. This an article I wrote in August 2007 that was recently rerun on The Oil Drum, where I used to be an editor.
Friday's NFP number brought us some altogether unprecedented BS from the BLS. Much has already been said about the filthy stench emanating from these "data points", so I will just review the most important points here. First thing to note is that squeezing a record 1.2 million people out of the "labor force"(people who don't waste time looking for jobs that don't exist) is apparently a sure fire way to get the headline unemployment rate down to only 8.3%
ZeroHedge, as usual, does an excellent job deconstructing the self-contradictory nonsense that is known as the NFP jobs report.Record 1.2 Million People Fall Out Of Labor Force In One Month, Labor Force Participation Rate Tumbles To Fresh 30 Year Low
"A month ago, we joked when we said that for Obama to get the unemployment rate to negative by election time, all he has to do is to crush the labor force participation rate to about 55%. Looks like the good folks at the BLS heard us: it appears that the people not in the labor force exploded by an unprecedented record 1.2 million.
No, that's not a typo: 1.2 million people dropped out of the labor force in one month! So as the labor force increased from 153.9 million to 154.4 million, the non institutional population increased by 242.3 million meaning, those not in the labor force surged from 86.7 million to 87.9 million. Which means that the civilian labor force tumbled to a fresh 30 year low of 63.7% as the BLS is seriously planning on eliminating nearly half of the available labor pool from the unemployment calculation.
As for the quality of jobs, as withholding taxes roll over Year over year, it can only mean that the US is replacing high paying FIRE jobs with low paying construction and manufacturing."
To make matters much worse, the number of long-term unemployed (27 weeks or longer) remains at a very high level of ~5.5 million and youth unemployment remains at 23%. And only 10% of the headline increase in jobs was due to additions for full-time employment, while a record 700,000 part-time workers were hired in January. ZeroHedge also follows up with a great analysis of the seasonal adjustment mechanism used by the BLS to turn manufacture millions of jobs out of thin air and turn a miss of expectations into a massive beat.
"What is very notable is that in January, absent BLS smoothing calculation, which are nowhere in the labor force, but solely in the mind of a few BLS employees, the real economy lost 2,689,000 jobs, while net of the adjustment, it actually gained 243,000 jobs: a delta of 2,932,000 jobs based solely on statistical assumptions in an excel spreadsheet!
So how does this data fit in specifically in the context of the just passed NFP whopper of a number? Simple. The chart below shows the January seasonal adjustment for the past 4 years, since 2009. The number of jobs added for "seasonal" purposes to the NFP number were as follows: 2009 - 2,006,000; 2010 - 1,970,000; 2011 - 2,129,000, and the all important 2012: 2,146,000.
Once again, this is the number added to the NFP unrevised baseline to get a "final" number which is then blasted to the media. The chart below shows the historical January adjustment, to the NFP data, as well as the 2012 reported adjustment, and also what the statistical adjustment would be for the NFP number to have the NFP number come in line with expectations of a 140,000 beat.
Here is the kicker: the market mood yesterday would have been far more somber if instead of a seasonal fudge-factored statistical addition of 2,146,000 jobs, the BLS had decided on a number that is merely the simple average of the statistical adjustment of the past 3 years, which comes down to 2,035,000. In fact, had the BLS used this seasonal adjustment, the final NFP headline number (SA) would have been +132,000, or a miss of expectations of 8,000 (the Seasonal Adjustment number to get to consensus January expectations would have to be +2,043,000 to the NFP number).
In other words, the difference between a + and - 2% move in the stock market is based on less than a 5% variation to the entire January seasonal adjustment, as had the BLS add just the simple average, the BLS report would have been a disappointing miss, and the market would have likely dropped (although with 5 momos in charge of the entire market, the thesis would have likely promptly shifted to "more QE coming" so who really knows)."
The combiniation of a horrendously exclusive "labor force" definition, extremely weak internals and a goal-seeked seasonal adjustment (significantly higher than recent average) make the NFP report the most highly manipulated and misleading piece of work to come oozing out of Obama's Administration yet. And Karl Denninger does a few more calculations to determine that, not only was this not a very good employment report as claimed, but it was actually the worst since January of 2009!
Employment Report: Blatant And Outrageous Lies
"Indeed, the total number of employed persons fell. A lot. To put a number on it, the total number of employed persons fell by 737,000 by actual count.
Now the cheerleaders will state that this is a common thing in January, and indeed it is. But the correct adjustment is to look at the population increase and subtract that back off as well. In other words, we take the loss of employment and add the population growth. When we do this we get a whopping 2.422 million in the wrong direction which was bested only by the -2.618 million in January of 2009 through the process of this downturn!
In fact other than January 2009 there has never been a single month in my table, which dates back to 1999, that put up a worse combined number. This "performance" rates a literal "second from utter despair and disaster", and the employment rate shows it:"
This sort of aggravated manipulation/miscontruction will become commonplace in the months ahead of November’s elections and it does carry real consequences, beyond simply buying a few points with the market. Sports radio pundits are reporting that some 5 million (!) Americans are going to buy new televisions to watch The Superbowl, and jobs reports such as this one will give them unjustified comfort when making such horrible decisions.
Why put off a several hundred dollar purchase on credit when you are confident that there are plenty of jobs waiting for you or that your current job is safe? Why not take out a few loans from Sallie Mae and enroll in that graduate program when the economy is in full recovery mode? The people lured into consumer-friendly complacency by these faux reports and the media lackeys who shill for the status quo will have a very rude awakening when all their bills come due, and it turns out the jobs were never there to begin with.
Yet, there is also a growing section of disenfranchised Americans who will be forced to trust their own lying eyes and [lack of] paychecks over the juked statistics from federal agencies or Jim Cramer's insufferable blather. Perhaps the biggest consequence of these manipulations will be to completely undermine confidence in the crony corporatist establishment. Still, it may take some more time for the harsh realities of Depression to set in across the all-consuming middle-class of America, which starkly contrasts with the situation in Europe.
Say what you will about the Eurocrats – they are power-hungry shysters who work through endless circuits of Summits and acronymous funds, turning their citizens into full-blown debt slaves just so they can keep the current crop of banksters and politicians in power, while the latter bumble, tumble and stumble towards any temporary “solution” to be had, no matter how useless, unjust or counter-productive it is – BUT they do produce much more legitimate economic and financial data than their American counterparts.
They still offer a hint of transparency to their citizens; something that has been utterly stripped away from the American populace over these increasingly painful years. There is no doubt that the peoples' plight is much more acute in Europe right now, where many of those living in the periphery are struggling to make ends meet every hour of every waking day. Eurostat gives us the latest unemployment data for the EU-27 and the Eurozone (17), and it’s grim.Unemployment Statistics
"Eurostat estimates that 23.816 million men and women in the EU-27, of whom 16.469 million were in the euro area (EA-17), were unemployed in December 2011. Compared with November 2011, the number of persons unemployed increased by 24 000 in the EU-27 and by 20 000 in the euro area. Compared with December 2010, unemployment increased by 923 000 in the EU-27 and by 751 000 in the euro area.
The euro area seasonally-adjusted unemployment rate was 10.4 % in December 2011, unchanged compared with November 2011; it was 10.0 % in December 2010. The EU-27 unemployment rate was 9.9 % in December 2011, also unchanged compared with November 2011; it was 9.5 % in December 2010.
Among the Member States, the lowest unemployment rates were recorded in Austria (4.1 %), the Netherlands (4.9 %)and Luxembourg (5.2 %), and the highest rates in Spain (22.9 %), Greece (19.2 % in October) and Lithuania (15.3 % in the third quarter of 2011).
In December 2011, 5.493 million young people (under 25) were unemployed in the EU-27, of which 3.290 in the euro area. Compared with December 2010, youth unemployment increased by 241 000 in the EU-27 and by 113 000 in the euro area. In December 2011, the youth unemployment rate was 22.1 % in the EU-27 and 21.3 % in the euro area. In December 2010 it was 21.0 % and 20.6 % respectively. The lowest rates were observed in Germany (7.8 %), Austria (8.2 %) and the Netherlands (8.6 %) and the highest in Spain (48.7 %), Greece (47.2 % in October) and Slovakia (35.6 %)."
These levels of youth unemployment are obviously a recipe for disaster, economically and socially. EU peripheral nations are tasked with growing themselves out of severe, structural deficits, but the figures above, among many others, tell us just how unrealistic that has been all along. Spain wants to cut its budget deficit nearly in half over two years when close to a quarter of its population, and almost half of those under 25, are not earning a regular income.
If the Troika and Mariano Rajoy get their way and spending on healthcare, education, etc. is gutted across Spanish regions, it will be even harder for any of these people to find employment, pay off various debts and consume at anything close to levels that sustain growth. The numbers put out by the EU may be more accurate than those pubished in America, but that’s little consolation to the men, women and children across the Continent who those numbers represent.
I’d like to get back to the BLS’ latest propaganda, though, and point out one other very important consequence of the report. It appears the rabid momentum chasers are once again picking up pennies in front of a gigantic steamroller, since everything in Europe is still as uncertain and unstable as it ever was and, on top of that, the bogus U.S. data may have just killed the one thing that investors have been taking to the bank for many months now – large asset purchases by the Fed.
I wouldn’t go so far as to say that some scale of QE3 has been “priced in”, but it is clear that the markets are now thoroughly addicted to credible promises of cheap, never-ending liquidity; or, as they would tell you in AA meetings, one sip is too much and one trillion sips are never enough. The problem for them now is that there is very little credibility left underlying the Fed’s “promises”, thanks to the complete joke of a jobs report produced by the incumbent politicians guiding the BLS.
With unemployment data suddenly showing massive improvement above expectations last month (and the non-manufacturing ISM reporting price increases across several commodities), the U.S. government has placed itself back in a position where there is simply no justification for any monetary easing. The Administration will continue to goose any and all economic data it can get its hands on going into elections, which will make it that much more difficult for the Fed to act, which, in turn, will make it very difficult for the market to keep up its appearances.
I believe it would be a mistake to assume that this fact has been lost on large money managers, as the following snippet from The Guardian Blog suggests.
Guardian Live Blog
"The drop in the unemployment rate to 8.3% means it is at the lower end of the Federal Reserve's forecast range - which could provide fuel to those in the Fed who want to hold back from further measures to boost the economy. Joshua Raymond, chief market strategist at City Index, said:
'This is a really stellar set of numbers and has surprised many who had expected a slowing of jobs growth after the December holiday period.
The jobs figures paint quite a different picture to the tone of voice used by the Federal Reserve last week, which applied a somewhat dovish tone towards US growth expectations. This naturally poses the question what are the Fed seeing further down the path that the market isn't right now?
And what's more, a stronger than expected labour market goes directly against the rational to increase asset purchases through quantitative easing, and this may pose a somewhat negative impact in the medium term for those investors that had factored this into their trading.'
Within the figures private sector jobs rose 257,000 while government jobs fell by 14,000, compared to expectations of a 20,000 drop. The increase in non-farm payrolls is the biggest since April 2011."
We could call it the mirror image of 2009-10, when all that mattered to the American political and financial elites was goosing the markets to manage perceptions of economic health and churn trading profits. As housing, jobs and manufacturing data naturally worsened (with exactly zero jobs created in August 2011, later revised slightly upwards) and the electioneering switch was flipped, the politicians have taken precedence over the bankers and are manipulating the source data with the belief that the markets will naturally play along.
What the politicians fail to understand is that the feedback between the real economy and the markets, to the extent it existed, has been irreversibly corrupted over the last few years through centralized intervention. You can goose all the data you want, but the increasingly fewer traders [or robots] that make up "the market" these days only want one thing – more monetization of debt. And, until now, most of them have been too clueless to figure out that unrestricted printing of money is not a guaranteed outcome in 2012.
This is something that TAE has consistently pointed out for quite some time now, while others have declared that money printing is the end all and be all of the system. Ultra-loose monetary policy and some form of printing will be a staple feature of our world for some time to come, but let’s remember that the financial system is not isolated from the sociopolitical system or vice versa. Both the probability and effectiveness of money printing will hinge on numerous variables, three of the most important being systemic deleveraging, social confidence/mood and political manuevering, and all three of those are coming to a head this year.
After the Fed’s latest announcement on January 25, in which the central bank said very little more than the obvious ("exceptionally low" fed funds rate at least through late 2014), we have returned to typical speculations about how much “money printing” (or quantitative easing) by central banks we will see in upcoming months to accompany these low rates. Perhaps the Chief Speculator is Tyler Durden at ZeroHedge, who never backs down from an opportunity to re-assert (or manufacture) the near-term bullish arguments for gold. This article will review some of the more notable and ridiculous opportunities seized over the course of only a few day following the FOMC release. Each one was a relatively short and sweet post that showcased a nifty-looking correlation chart. I do realize that Durden wasn't claiming any of these posts as an extensive and irreproachable analysis, but the fact is that he decided to put them up for a reason. Soon after the Fed’s announcement, ZH ran the following headline and analysis [emphasis mine]:Market Now Pricing In $770 Billion Increase In Fed Balance Sheet As we have pointed out previously, the primary if not only driver of relative risk returns (because in a world of relative fiat value destruction, it is all relative, except for gold which is revalued relative to all on a pro rata basis), will be who of the big two - the Fed and the ECB - can print more. And up until now, at least since the end of December when the market "suddenly" realized that the ECB's balance sheet has soared to unseen records, the consensus was that it was the ECB that would be the primary source of easing. Especially when considering that there is another ~€500 billion LTRO due on February 29. Yet today's rapid reversal in the EURUSD, driven by Bernanke's uber-dovish comments suggest that something has changed and that the Fed is now expected to ease substantially. How much? For that we look to the latest balance sheet cross-correlation, where if we go by simple correlation, the market is now pricing in (based on the EURUSD cross ratio) that the relationship of the two balance sheets will rise from a multi year low of 1.08 as of a few days ago to 1.15, at least based on the rapid move in the EURUSD higher as can be seen in the chart below. Indicatively, the actual value of the two balance sheets is €2.706 trillion for the ECB and $2.92 trillion for the Fed (or a 1.08 ratio). So now that the EURUSD has risen as high as it has, it implies that the pro forma "priced in" ratio is about 1.15. But wait: one should also factor in the fact that the ECB's balance sheet will rise by at least another €500 billion in just over a month, which will bring the ECB's balance sheet to €3.2 trillion. Which means that to retain the 1.15 cross balance sheet relationship, the Fed's own balance sheet will have to rise to $3,687 billion, or a whopping $767 billion increase!"
Essentially, he is saying that the reaction in the EUR/USD pair after Bernanke’s statement had implied that the movers and shakers in the currency markets expected the dollar to be devalued by the Fed in the near future through quantitative asset purchases. Since the pair moved to levels that "imply" a ratio between the size of the Fed and ECB's balance sheets higher than currently established (based on loosely-correlated movements over the course of 2 years), and the ECB is expected to unleash at least another €500bn next month, we can project that the Fed will unleash a response of $767bn (or thereabouts). To Durden’s credit, he provides a partial explanation of why we should probably dismiss this entire train of thought in the very next sentence that he writes.Naturally, that's a simple heuristic based on only what the EURUSD pair is implying. Of course, this is not a scientific way of predicting where Bernanke will go, but that is at least what the market seems to be telling us.
To only say that this mode of prediction is non-scientific is to do all forms of non-scientific economic analysis a huge disservice. It is patently ridiculous to think there is any connection whatsoever between the immediate reaction of a currency pair to a Fed announcement and either the expectations OR the actual value of future asset purchases by the Fed (even ignoring the fact that Bernanke's comments were not much more "uber-dovish" than they have ever been over the past year). It is much more likely that the EUR/USD has simply been moving with the perception of financial risk in the Eurozone this whole time, and perhaps with the expectation of ECB “money printing” since mid-2011. The markets' perception of risk is most certainly tied into the Fed’s QE asset purchases (or the lack of them in 2H 2011) during waves of greed/fear, but all of that is a very far cry from the currency pair acting as a predictive indicator of money printing. Durden almost admits as much above before reverting back to his goal-seeked analysis in pursuit of a predictable conclusion.So at the end of the day, the balance sheets of the world's two biggest central banks will increase by about €500 billion for the ECB and ~$770 for the Fed and $655 billion for the ECB. Incidentally, this analysis assumes all else equal which, with Greece on the verge of default and Portugal potentially in its footsteps, isn't... Thus our question is: gold is not on its way to $2000 yet why again?
It is really unfortunate that such an informative and clever site occasionally feels forced to produce such weak arguments in favor of, what else, gold. The truth is that no one can be certain when Bernanke will decide to pull the trigger on QE3 or how much the Fed’s balance sheet will actually be expanded in nominal terms or relative to the ECB’s balance sheet, and analyses such as the one above provide us with no clearer picture of those possibilities than we had before. It only serves to confuse the issues at hand and provide us with a sense of predictive confidence that we simply can’t have. What we do know is that the Fed’s perpetually low interest rates and the potential for another few hundred billion in QE are very unlikely to make a dent in the ongoing global deleveraging tsunami, and therefore the natural flight to safety away from currencies such as the Euro for U.S. Treasuries and the U.S. Dollar. That is even truer if the ECB floods the European banks with another €500b to €1tn of LTRO funds in February, since very little of that money will actually make it to the distressed consumers, businesses and sovereigns that need it the most. The next day, ZeroHedge asked semi-rhetorically whether Bernanke has become a “gold bug’s best friend”. The logic contained within this brief analysis is similar to the one presented above, as it tries to connect the Fed’s statement and Bernanke’s comments on Wednesday to the subsequent positive returns of gold (and “implicitly silver”) over the 24 hours that came after [emphasis mine].Has Bernanke Become A Gold Bug's Best Friend? Below we present the indexed return of ES (or stocks) and of gold over the past 24 hours since the Bernanke announcement of virtually infinite ZIRP, and the latent threat of QE3 any time the Russell 2000 has a downtick. It is unnecessary to point out just when Bernanke made it all too clear that the Fed has nothing left up its sleeve, expect to directly compete with the ECB over "whose (balance sheet) is bigger," as it is quite obvious. What is not so obvious, is that for all intents and purposes, Bernanke may have unwillingly, become a gold bug's best friend, as gold (and implicitly silver) has benefited substantially more than general risk. Much more. So for the sake of all gold bugs out there, could the Fed perhaps add a few more FOMC statements and press conferences? At this rate gold should be at well over $2000 by the June 20 FOMC meeting.
Granted, the first bolded statement above is quasi-hyperbole, but, then again, it’s not. ZeroHedge and others have been identifying the “latent threat of QE3” in the Fed’s various statements since the early days of 2011, well before QE2 even ended, which may as well be "any time the Russell 2000 has a downtick". The reality is that the Fed has no other choice but to leave open the possibility of further monetary easing in the near future, because otherwise it would be responsible for an uncontrollable downward cascade of markets around the world. And if one is looking hard enough to be vindicated for consistently repeated predictions of money printing to, as Buzz Lightyear would declare, “infinity and beyond”, then one will certainly find latent threats of such printing contained within almost all of the statements released by almost every central banker in the world. What’s much more disturbing is the notion that knee-jerk market reactions to these statements by precious metals (which is fittingly compared to “general risk” in the graph) are somehow indicative of a sustainable price trend. In the next paragraph, we get the caveat that it is not all “smooth sailing” for gold, because rumors of CME margin hikes or actual hikes could surface at any moment and destroy the otherwise developing moonshoot in gold and silver. That’s actually not really a caveat as much as a re-assertion of the flawed premise that market demand for PMs is indestructible outside of centrally-coordinated “takedowns”. What they don’t mention is that debt deleveraging (something quite prevalent these days) is the equivalent of demand destruction, and that’s all a margin hike really is. To top off a series of highly flawed and misleading analyses, Durden follows up the next day with a posting in which he states that Tim Geithner has been added to ZeroHedge’s list of “best Goldbug friends”. Why, you ask? Because there appears to be at least some correlation between increases in the U.S. debt ceiling and increases in the price of gold over the last 10 years. Therefore, the latest increase of $1.2tn in the debt ceiling means Geithner can spend more money for at least a few more months, which means gold can keep going up!
Frankly, I don’t see much of a correlation until at least 2005, besides both the debt ceiling and price of gold steadily increasing over the last decade, which should be no surprise for either of them (excluding the sharp declines in gold price during risk-off phases of 2008 and late last year). To the extent a meaningful correlation does exist, there is really no reason to infer any sort of causation when a whole slew of variables independent of the debt ceiling can explain why gold has generally been on the rise since 2009, including all of the policies that have suppressed the dollar (such as low interest rates and monetization of MBS/Treasuries). Of course there is a connection between the government spending/borrowing and the Fed monetizing debt in unprecedented amounts. The USG already made clear it would be spending/borrowing this money last year (and more), and of course it will end up becoming a huge problem for the U.S. and its currency down the line. How exactly any of that, or this specific instance of Congress raising the debt ceiling, translates into a “green light” for gold to reach $1960/oz. soon is a very different story. It is a story that really has no credible basis in reality and serves only to support a pre-determined objective. Among the plethora of very useful reports/analyses produced by ZeroHedge on a daily basis, these brief postings may not seem like such a big deal. However, they represent a goal-seeked mentality and modus operandi that is frequently on display within the HI/gold crowd and can lead to very misleading conclusions. I can’t be certain, but I’m pretty sure we will see many, many more postings like the ones above over the course of this year, and they will appear almost exclusively when it comes time to discuss gold. None of the above is meant to suggest that the price of gold will plunge into the abyss in the near future, but it is meant to suggest that there are significant risks of gold failing to hold its current valuations around $1700/oz, let alone reach $2000/oz and beyond. These risks are especially formidable when we stop pretending like the Fed, ECB, Bernanke, Geithner or anyone else is in a good financial or sociopolitical position to halt the upcoming waves of debt deflation. We here at The Automatic Earth only ask that you keep these risks in mind as you continue to read and contemplate your future allocations of cash.
National Photo Co. Bond Vault 1914 "Treasury Department, Office of Comptroller of Currency -- bond vault. Contains bonds to the value of $900 million securing government deposits and postal savings fund"
I’m not a technical analyst or a fundamental analyst or any other type of equity market analyst. What I am is just a guy who likes to think he can spot completely nonsensical propaganda when he reads or hears it. You know, the type of non-stop propaganda that attempts to manage perceptions/expectations and convince "investors" that, while things are obviously very bad in the real economy, everything is still just hunky dory in the wonderful world of equities. Case In Point Some mainstream market analysts chimed in after the serial S&P ratings downgrades of nine Eurozone countries, and specifically the one-notch downgrade of France from AAA to AA+ (ratings outlook still negative), to say that the market had already "priced them in" and therefore they are really no big deal. S&P had put all of these countries on negative watch back in December before the latest and unsurprisingly innocuous EU Summit, so the downgrades were no surprise. Here are just two examples of a very pervasive and perverse logic, presented by The Telegraph:S&P cuts ratings of nine eurozone countries: reaction Fabrice Seiman, head of Lutetia Capital, said: "S&P is absolutely right. France is paying the price of 30 years of irresponsibility in public finances. French politicians on the right and on the left fell short of the job by not taking measures to reduce spending." I think this is already priced in. There should not be any sizable reaction, but there could be a technical reaction on the Franco-German spread. It should be limited to the long-term and if there is a reduction in spending." Bill O'Grady, chief market strategist at Confluence Investment Management, said: "If France had been downgraded more than one level it would have precipitated a crisis. This is not good but it was anticipated, baked in. For oil it is probably a neutral event. If it raises concerns about a worsening economic environment it would be bearish."
Ashvin: That logic does sound appealing on the surface and many others like to parrot it, but the first question to pop into my mind was this – how can the market "price in" very significant developments in Euro sovereign credit markets by steadily increasing in valuation since they became aware those developments would occur?? Since the S&P put a bunch of EZ countries on negative watch on December 5, 2011 and the EU Summit on December 9, the S&P500 has risen almost 6%.
That’s a boat load of downgrades the market appears to have priced in over the last month while very little "positive" news has come out of Europe. Now I’m confident that the initial reaction to my question above would be, "that’s a really simple and stupid question to ask!". Fortunately, there are several great analysts out there who have reached similar conclusions about these equity markets, which have allegedly "priced in" everything under the Sun, and have provided us with slightly more nuanced arguments than my own. The U.S. Dollar (and Treasuries) has been increasing in value alongside U.S. equities, so the pundits should find it very difficult to explain the upwards "pricing in" market action of the last month by saying it is a nominal increase of shares priced in dollars. What we have is a very significant divergence between the dollar index and equities, as Charles Hugh Smith outlines in his piece, A Useful Fiction: Everybody Loves a Melt-Up Stock Market, and one that must close in the near future. The following charts of the dollar index ($DXY) and 5-year Treasuries are from M3 Financial Analysis:
The truth is that the very notion of the market "pricing in" events as the investor collective becomes aware of them is flawed. In the comprehensive TAE classic of 2010, Fractal Adaptive Cycles in Natural and Human Systems, Nicole Foss delves into Robert Prechter's theory of "Socionomics" (among other things) and how it can explain market valuations as a function of endogenous factors, such as the collective mood of investors, rather than exogenous events relayed by "the news".Bob Prechter's socionomics model combines Elliott's observed fractal patterns with an understanding of human herding behaviour, comprising a comprehensive challenge to prevailing notions such as the Efficient Market Hypothesis by reversing causation and recognizing the role of emotional/irrational behaviour as the prime market driver. While the real economy demonstrates negative feedback loops, finance is thoroughly grounded in positive feedback.
Ashvin: Mish Shedlock also touched on this concept in a post earlier this week. He illustrated that, at best, the market should be viewed as a contrarian indicator for future economic trends due to its function as a gauge of extreme sentiments, and, at worst, it shouldn't be viewed as an indicator of anything at all.Cherry Picking Timeframes on Alleged Leading Indicators; Big Change In LEI on January 26 "The stock market is not a leading indicator of the economy. Rather, the stock market is a coincident indicator of sentiment towards equities. ... Far from being a leading indicator, on an absolute basis the S&P has a perfect track record of peaking right before or just as a recession starts. This is just as one might expect from a gauge of equity sentiment which tends to peak right before a downturn in the economy (with everyone extrapolating good times forever into the future). ... On a percentage change basis, the S&P 500 is not leading, not lagging, and not coincident. Instead it is completely useless mush."
Ashvin: It's not just the "fringe bloggers" drawing these conclusions about the market, but also such "reputable" financial institutions as UBS. Granted, the well-intentioned bankers over there also point out that the French downgrade, among others, was expected and shouldn't affect near-term credit spreads too much. Instead, they choose to focus on the effects it will have on the state of realpolitik in Europe’s core, and how that is certainly not something which is "priced in" at all. Indeed, only market shills and fools can even pretend to separate the two (finance and politics).
Ashvin: So if the equity markets are "pricing in" anything, it's the pure hope that all of these downgrades of countries, banks and corporations will continue to be glossed over by bond markets, that political/economic imbalances in Europe haven't been exacerbated, that the Greek government and its creditors aren't helplessly struggling to reach a "voluntary" debt reduction deal before a technical default in March becomes inevitable, that China/India aren't facing "hard landings" and that the U.S./U.K. economies will not be dragged down by their own housing markets, corporate [lack of] earnings, unemployment trends or any of the above. Some people will tell you that the only thing the markets need to keep their manic phase intact is the inevitable QE money printing that the Fed will officially announce, which has conveniently been "just around the corner" for almost a year now. Despite those consistent predictions of QE3, I made clear that I didn’t expect the Fed to relent in 2011, and many of the same financial and political reasons underlying that expectation still stand. The primary reasons being the conundrum reflected by the fact that the S&P is still hovering around 1300 (and oil around $100/bbl), which makes the marginal benefits of QE very slim, and the politically volatile situation in the run-up to November’s elections. On the other hand, the financial threats from the Euro crisis and a strong dollar (weak euro) have clearly intensified over the last few months, and the ECB is even more constricted from printing than it has ever been (at least for anything other than sub 3-year sovereign paper through its indirect LTRO, which still doesn’t reflect net cash entering EZ bond markets). Perhaps these developments will finally convince the Fed to "pull the trigger" on QE3, but then many questions still remain – how many trillions are needed to boost "risk appetite" for more than a few weeks and what happens when those trillions are perceived as "not enough"? Like I said at the beginning, I'm not any sort of market analyst, but there do seem to be a whole slew of developments starting to weigh on collective investor sentiment right now, which will only get heavier in the upcoming weeks and months. No one can tell you that any of these negative and ongoing developments herald an imminent market crash or how exactly they will impact shares. What I can say with confidence, though, is that none of them are insignificant bumps in the road. They certainly did not "remove any uncertainty" from the markets and they have in no meaningful way been "priced in" by these markets either.