Thursday, October 23, 2008

Deflation vs. Deleveraging

There has been a lot of talk in the news recently about the new deflationary scare taking hold of the markets. As the stock market began to crash in 2000, many people were having the same conversations. In order to respond to this crisis, our former financial leader (who happens to be taking the stand today) Alan Greenspan decided to lower interest rates to 1% and hold them there for years. This took care of our "deflationary" problem.

Unfortunately, no one understands what they're talking about before they even start the discussion. The definition of:

Inflation = An increase in the money supply

Deflation = A decrease in the money supply

Prices rising is not inflation, it is a symptom of inflation. Prices can also rise because the value of a currency falls, causing imports to be more expensive. Prices can also rise because the supply of goods falls relative to the amount of currency in the system.

Prices falling is not deflation, it is a symptom of deflation. Prices can also fall because the value of a currency rises, causing imports to become cheaper. Prices can also fall because the demand of goods falls relative to the amount of currency in the system.

What we are seeing today is an explosion in the money supply. The Federal Reserve teamed with our government, are printing money at an unbelievable pace. The following chart shows the year over year increase in the money supply:

As you can see the percentage increase of dollars entering the system is rising at an unbelievable rate, about 12.5%. (M3 shows total money entering the system, it would take me a while to explain the difference between the three M's and I'll do so at some future point)

But why are prices falling? Is is because of deflation? No, it's because of deleveraging. Right now banks, hedge funds, a few companies, and some every day people are having to sell everything possible to stay solvent.

Hedge funds leveraged themselves up 30 to 1 over the past few years with mortgage securities. They have to keep a certain percentage of equity to assets or they are considered insolvent. The best way to think of this is to imagine that you bought a $500,000 house with no money down. The bank then calls and says they need to see that you have $50,000 in cash in order to keep your mortgage. You have no money saved because you were not planning on getting that phone call. So what do you do? You can either declare bankruptcy, or you can sell everything in your 401K, your gold, silver, commodity stocks, cars, clothes, children, and pets.

That's what the hedge funds and banks are doing right now and it's driving the price of EVERYTHING down. There is no market for mortgage securities right now. (Except for what the government and the Fed are putting on their books) The marketplace will not buy them at any price. In order to stay solvent and cover the losses, they have been forced to irrationally sell everything they have, including their best assets.

This is giving the Fed the opportunity to print money in amounts unimaginable only a year ago, and it is allowing the government to go into debt at a blistering pace. This, they say, is all to protect the country from the horrible prospect of deflation.

Trades are settled in the short term into cash positions because *right now* the dollar is the world's reserve currency. Also, a tremendous amount of money has come out of the markets and gone into cash as part of the deleveraging process for companies and individuals. This has irrationally pushed the dollar's value higher in the short term and irrationally pushed the dollar value of many assets lower in the short term. It has given what could be one last amazing opportunity for investors to exit the dollar before the currency begins its final collapse.

Monday, October 20, 2008

Insane Running the Asylum

Shocking news to some this morning as headlines streamed across; "Default rates are soaring for American auto loans and credit card loans. Lenders are tightening up." Who could have seen that coming?

During 2006 and 2007, Americans took out about $50 Billion every quarter to finance their ridiculous lifestyles. In 2008 as the losses poured in and banks realized they would not be paid that money back, they cut off the American ATM machine.

So instead of realizing they were in serious debt and deciding to cut back spending and start to save money, Americans did the only thing they know how to do; they looked for a new way to borrow money. It was not too hard for them to find because all they had to do was open up their mail every month to find a brand new credit card asking to be used. And use it they did. The ones that didn't need it continued to finance their lifestyles and the ones that were counting on the home ATM machine were now using credit cards to make ends meet every month.

Guess what? They are now starting to default on all that credit card debt, and credit card companies are starting to realize that they won't be paid back. Don't feel too bad for them though. I'm sure the company heads that held the greatest amount of stock sold off months ago. When Visa went public a few months ago, I had written that it would be the crime of the century, as insiders sold stock to the public that would then collapse in value.

In the past few months credit card companies have done exactly what the home builders did in the beginning of 2007. When they realized that people were no longer buying homes they started a tremendous amount of unsold inventory homes. The numbers hit Wall Street that "new home starts were way up to start the year." The insiders then sold off their shares while the people that bought in got slaughtered.

The same thing has happened with the credit card companies the past few months. They have lent out as much as possible and investors saw all the new profit potential with the revenue the companies would bring in from the interest on these loans. Unfortunately, just like the money lent out to homeowners, none of it will materialize because they will not be paid back. Car loans are now facing the same problem.

So now what? How are the Americans going to keep spending? Don't worry, another major headline crossed the wires this morning that the government is in discussions for another stimulus package by the end of the year. The government is going to send people money directly again. The insane are running the asylum.

The leader of the destruction of this country, Ben Bernanke himself, this morning urged Congress that additional "stimulus" was necessary.

Sunday, October 19, 2008

Speeding Up to the Edge of the Cliff

It's interesting to note that the counter to my left has recently crossed over the $10 Trillion deficit mark. If it seems like it has sped up the count tremendously over the past few weeks, it is not your imagination. The following chart shows our deficit climbing since the year 2000.

9/30/2001 - ($5,807,463,412,200.06)
9/30/2002 - ($6,228,235,965,597.16)
9/30/2003 - ($6,783,231,062,743.62)
9/30/2004 - ($7,379,052,696,330.32)
9/30/2005 - ($7,932,709,661,723.50)
9/30/2006 - ($8,506,973,899,215.23)
9/30/2007 - ($9,007,653,372,262.48)
9/30/2008 - ($10,024,724,896,912.49)

Over the past fiscal year (Sept 30, 2007 through Sept 30, 2008) our deficit has grown by $1 Trillion. With the current policies now being implemented by our leaders, the deficit is predicted by many to grow by over $2 Trillion this fiscal year. (Sept 30, 2008 through Sept 30, 2009)

Does that sound crazy? In the past 16 days, the first of this current fiscal year, our national debt has grown by $331 Billion. 16 Days. It has taken 16 days for the government to borrow 1/3 of what it borrowed all of last year.

When you factor in all unfunded liabilities, including social security and medicare, recent Fed officials have estimated it to be over $110 Trillion. What does this mean? It means every day we move one step closer to the rest of the world realizing that if they lend the US money they will never be paid back.

Keep your eyes on the bond market, the dollar index, and especially keep your eyes on the price of gold.