Where will the inflation manifest?

First, the current policies will need to remain or continue to expand. Should the Federal Reserve change course and start withdrawing the created liquidity, then an inflation might be avoided. That potential window of opportunity is fast closing currently.

Currently, we are still seeing Bank failures amongst banks deemed too small to save. This while patently unfair, is simply what really should have happened to the larger failures that have been propped up, Citi et al.

Eventually the bank failure rate will slow and end. At that point we will be left with healthy banks that survived on their own merits, primarily the smaller regional banks and the large, artificially saved money centre banks that are puppets of the Federal Reserve, itself a puppet of government.

Capital will be assigned to the relatively more profitable stages of production. Unless we continue to see sustained voluntary saving from the consumer, that area will be consumer goods. Even in a heightened saving environment, consumer goods will be relatively more profitable.

That being the case, we should expect in the future to see some increase in employment within this sector.

Within the initial data series we can see that retail/food sales dropped significantly. While the employment picture was also bad, it has held up relatively well when compared and contrasted within two capital goods intensive industries, consumer durable goods and mining.

Profits, while they may well be diminished within consumer goods, will remain higher relatively than they are in capital intensive industry due to the tighter credit conditions imposed by the banking sector. Labour will relative to capital become cheaper. Thus, the increased profitability of the consumer goods will attract a relative expansion in this sector, and a severe contraction in stages of production furthest from consumption.

The outcome will be a gradual absorbtion of inventory levels, which currently are still high. This high inventory level will cap currently any inflationary pressures within the consumer goods.

We can see from the PMI data however that purchases are starting to pick-up from the plunge initiated from the credit freeze-up.

As this trend continues, we will hit a snag. Productivity will have been hamstrung via the poor choices manifested via the manipulated interest rates. The demand will start to exceed the supply, thus prices will start to rise to reflect this imbalance. Capital will have been consumed. The productivity cannot just be switched back on. Therefore the shape and depth of productive capability are inappropriate for the emerging and artificially stimulated consumer demand.

The stimulus packages by creating a new and increased money supply underpin this demand for consumer goods. The stage is set for a rapidly escalating inflationary scenario and new problem for the Federal Reserve – whose traditional response is to raise the short-end of interest rates, thus pushing up the long-term interest rates.

Various raw commodities also act as consumer goods, viz. oil [coal, gas] that produces petrol, electricity, heating etc. In an inflationary environment, they will maintain their exchange values, thus matching and in another potential speculative frenzy, possibly exceeding [again] real exchange values.

In summary, inflation always is insiduous, markets are always hyper. That there is little detectable inflation currently, although it is already there in some commodities – oil, agriculture, it has not yet invaded the public domain in CPI based calculations. Due to forces already in play, launched via the Federal Reserve and government, these forces are set to increase.

 

Sarah Palin

Obama as far as what ails the US economy is clueless. Sarah Palin, so the rumours go has given up the governorship of Alaska to better raise money and support for a run at the Presidency.

You go girl.

 

S&P500

Technically, not looking so hot.
*H&S pattern
*Divergence pattern
*First test of 50MA & 200MA

Fundamentally, the economy remains poor. The policies that are in place are not the right ones, thus there can be no sustainable recovery. We will [based on the economy] chop in a range until the policies currently in place are abandoned, or, they cause a further serious breakdown in the economy.

Could we retest the March lows?

Quite possibly, I see no reason why not, save for the credit expansion currently being engineered by the Federal Reserve. If rumours circulate that the credit expansion will not continue, then I think the lows would be retested.

The bounce from the March lows was engendered largely [entirely] on a massive credit expansion via The Federal Reserve. Insiders have been selling stock at unprecedented rates recently into the rally. This new supply will not be absorbed unless new money is created to absorb this supply.

Additionally we have new rumours of the reinstatement of the short-selling ban. This utterly failed last time, which even in the absense of any other reasons should be enough to nix the idea. That short-selling actually limits declines by providing a buying source [shorts buying to close trades] shows the total lack of any understanding from those in charge.

So if the rumour is true, or even if it’s not, the markets again are faced with increasing uncertainity, which, almost invariably leads to selling.

 

Rebuttal of a rebuttal

Some more economics.

It is usual nowadays to characterize classical economists as antiquated halfwits whose “teaching is misleading and disastrous if we apply it to the facts of experience.”[1] This characterization could perhaps be applied more justly to Keynes’s own theory. It is certainly not just when applied to the classical economists, who were familiar with the effects of manipulations that increase the supply of money.

They were well aware that booms can be provoked and prolonged by inflation. Their vehement protests were founded on very extensive experience and acquaintance with the monetary depreciation, debasement of coins, and bank-note experiments of the Mercantilist and post-Mercantilist periods.

No classical economist denies that, in the first stage of an inflation, prosperity spreads as if by magic. Yet this prosperity is unreal; nowhere is it depicted more brilliantly than in the second part of Goethe’s Faust.

Prices rise faster than costs and profit margins are widened, rendering new enterprises profitable. For the following reasons, however, the stimulus soon loses its force:

On the one hand, prices break after a certain time unless new doses of the inflation poison are injected (and if they are, the experiment ends with the destruction of the currency).

A rise in prices leads entrepreneurs to expect further rises. Consequently, they make new investments and build inventories, which in turn operate to boost prices further.

The moment the stimulus of rising prices is exhausted, the cumulative boom spiral reverses its direction. Since there is no new stratum of buyers on whom the bulls can unload, the downward movement gains momentum.

The English economist, A.C. Pigou, gives a penetrating description of the process in his Industrial Fluctuations (London, 1927). In an economy dependent largely upon exports, prices collapse even earlier: under the impact of the rising domestic price level, the balance of payments deteriorates, and the outflowing gold causes a deflationary process within the country, as David Ricardo described clearly in his 1810 pamphlet, The High Price of Bullion.

This rebuttal originated in 1947 disclaiming against Lord Keynes. I’m certainly not defending Lord Keynes, rather, the reasons and conclusions drawn by the author.

Prices rise faster than costs and profit margins are widened, rendering new enterprises profitable. For the following reasons, however, the stimulus soon loses its force:

To this point, essentially I agree. It is the incorrect analysis however in the structure and function of the profit margin that I take exception to.

On the one hand, prices break after a certain time unless new doses of the inflation poison are injected (and if they are, the experiment ends with the destruction of the currency).

A rise in prices leads entrepreneurs to expect further rises. Consequently, they make new investments and build inventories, which in turn operate to boost prices further.

Not stated is which stage of production are [in an inflation] profit margins are rising? Actually, the answer is not vitally important as eventually they will move to consumer goods, irrespective of where the increased profit margins due to an inflation started.

Thus the first question must be: are the increasing profit margins real? If your costs, in stages of production furthest from consumption are incurred first, which by definition they are, as time is a factor in moving from the furthest stages of production to consumption, the money profits, or accounting profits will be false.

Second. Whichever stage of production enjoys the increased accounting profit margin, will attract economic agents. Thus, capital will be removed from prior stages of production. Classically, inflation effects the margins at the stage of consumer goods – due to the lack of real savings.

Real savings mandate that consumption in present goods are sacrificed to increase production in earlier stages. Inflation, via an expansion in fiduciary media, allows consumption to progress unhindered, thus increasing the accounting profits.

This profit, that draws capital from earlier stages, prevents the expansion of produced goods, and in point-of-fact actually reduces the production of goods as capital is removed.

It is this contraction in supply of newly produced goods, with no inhibition of demand, that drives the increase in prices.

 

Banks

With one bound the banks are free, or so it seems. Already, the panic of the autumn of 2008 is fading. The period within which lessons can be learnt and changes made is closing. Yet without radical changes, another crisis is certain. It may not even be that long delayed.

In a recent speech, governor Elizabeth Duke of the Federal Reserve told an anecdote from just after the failure of Lehman Brothers last September. Ben Bernanke, chairman of the Federal Reserve, was asked: “Well, what if we don’t do anything?” To which he replied: “There will be no economy on Monday.” Instead, all institutions deemed systemically significant were saved, by shifting almost all of the risk on to taxpayers.

“Never again” might be too much to ask. But “not for a generation” is essential. Governments cannot afford an early repeat, financially, politically, perhaps morally: the lives of so many cannot soon be sacrificed to the whims of a foolish few.

Yet what has emerged after the crisis is, as I argued last week , an even worse financial system than the one with which we began. The survivors are an oligopoly of “too-big-and-interconnected-to-fail” financial behemoths. They are the winners not because they are necessarily the best businesses, but because they are the best supported. It takes no imagination to realise what these institutions might now do, given the incentives for risk-taking.

So what is to be done? The characteristic, but futile, response is to move the regulatory deckchairs on the deck of the Titanic. Recent proposals from the US Treasury fall partly into this category. But the financial system had to be rescued from its own mismanagement of risk. This is not going to be changed by external supervision. It is going to be changed only by fixing incentives.

The starting point has to be with “too big to fail”. We need a credible system for winding up even huge financial institutions. The most attractive proposals are for “good banks”, in which unsecured creditors become shareholders. That would be easier if, as President Barack Obama has proposed, and Mervyn King, governor of the Bank of England, has argued, a regulated institution has to produce a plan for an orderly wind-down of its activities.

Yet bank failures are like buses: you do not see one for hours and then a fleet arrives together. The authorities cannot make a credible promise that they would be prepared to put all affected institutions through bankruptcy in a systemic crisis. This would be a recipe for still-greater panics. “Too big and interconnected to fail” is a reality. It is so, because, as Andrew Haldane of the Bank of England pointed out in a recent speech, the financial system is an increasingly tight network.*

My colleague John Kay has argued that the right response is to create “narrow banks”, which are perfectly safe, leaving the rest of the financial system to go on its merry way, subject to a then-plausible threat of bankruptcy. I find this idea both attractive and unpersuasive. The attraction seems evident. It is unpersuasive in part because it is so hard to agree on what narrow banks should do. It is also unpersuasive because the narrower the banks are made to be, the more vital is the role of the rest of the financial system and so the less plausible it is that governments would let it collapse.

If institutions are too big and interconnected to fail, and no neat structural solution can be identified, alternatives must be found: much higher capital requirements and greater attention to liquidity are the obvious ones. At present, big financial institutions operate with next to no capital: in the US, the median leverage ratio of commercial banks was 35 to 1 in 2007; in Europe, it was 45 to 1 (see chart). As I noted last week, this makes it rational for shareholders to “go for broke”, with the results we have seen. Allowing institutions to be operated in the interests of shareholders, who supply just 3 per cent of their loanable funds, is insane. Trying to align the interests of management with those of shareholders is then even crazier. With their current capital structure, big financial institutions are a licence to gamble taxpayers’ money.

So how much capital makes sense for systemically significant institutions? “Much more than today” is the answer. Moreover, the required capital must also not be risk-weighted on the basis of banks’ models, which are not to be trusted. Shareholders’ funds should make up a minimum of 10 per cent of assets. In the US, it used to be far higher.

Higher capital is, in addition, a good way to internalise the negative “externalities” – more precisely, risks – created by one institution for the entire system. Ideally, therefore, the required capital should be correlated with the systemic significance of institutions, as the excellent new annual report from the Bank for International Settlements argues. Moreover, the requirement should be set against all activities, on the basis of fully consolidated accounts.

Within a far better capitalised financial system, it would also be relatively easy to operate a “macroprudential” regime, with the required capital rising during booms and falling during busts. Again, the bigger the stake of shareholders, the less one would worry if the rewards of managers were aligned with them. Even so, regulators have to have some sort of control on the incentives of management, as long as taxpayers bear residual risk.

Two difficulties remain: the transition; and regulatory arbitrage.

On the former, a demand for much higher capital ratios today would imperil the recovery. The answer is a lengthy transition, perhaps of as much as a decade. On the latter, it is evident that the so-called “shadow banking” system cannot be allowed to operate outside capital constraints if entities within it are likely to be systemically significant, as proved to be the case for money market funds. Moreover, capital ratios would have to be imposed by all significant countries. But the US is powerful enough to force movement in that direction by insisting that any foreign bank operating within it must be appropriately capitalised.

In sum, deleveraging is the right starting point for a healthier financial system. This would work best if we also eliminated today’s huge fiscal incentives for borrowing.

It is cautious incrementalism, not radicalism, that is now the risky option. Where should such radicalism start? The answer is clear: it is the incentives, stupid.

What nonsense.

The banks can be reformed overnight near as dammit.
*Outlaw all Central Banks [Federal Reserve etc]
*Impose 100% demand deposit reserves on all banks.

By removing the Central Banks, banks would no longer have a provider of liquidity from the lender of last resort but, wouldn’t require one, as, 100% reserves allows them to meet any demand for liquidity from reserves.

Of course, this solution requires that unfunded credit expansions of the type that we are currently embroiled in, could not happen. Banks could only lend real savings via time deposits.

The abrogation of Property Rights that have been granted as a special privelege to banks, from government, so that they [government] could control the money supply would also need to end. Simply, gradually reintroducing a real money, such as gold would solve this criminal activity.

 

Norway #1

Immediately next door, while Sweden potentially implodes, Norway remains in #1 position as the safest credit on the planet. Something to do with a small population and lot’s of oil.

Here’s a picture constituting part of the 500 acres we own in Norway.

 

Sweden cuts to -0.25%

DATE 2/07/2009
The weak development of the economy requires a somewhat more expansionary monetary policy. The Executive Board of the Riksbank has therefore decided to cut the repo rate by 0.25 of a percentage point to 0.25 per cent.

Deep economic downturn

Economic activity abroad is very weak and this hits Sweden hard. Exports have fallen substantially and the situation on the labour market is continuing to deteriorate rapidly. The information received in recent months points to the economic downturn in 2009 being somewhat deeper than the Riksbank forecast in April.

Deposit Rate

The decision on the repo rate will apply with effect from Wednesday, 8 July. The deposit rate is at the same time cut to -0.25 per cent and the lending rate to 0.75 per cent.

Not stated is the type of deposit whether demand or time. This distinction is critical. Assuming the worst outcome for a moment, that they are referring to 90 day time deposits, the rate of voluntary savings will likely fall to zero. Instead people would need to move further out, thus placing savings at risk to inflationary pressures, without being properly compensated for the risk.

If on the other hand, demand deposits are the focus, then this is simply another expropriation from government, compounding the problem of fractional reserve banking and the lack of reserves to provide liquidity if required.

Either way, this bodes ill should more major players in global terms [US, UK, Japan, China] decide that this is an experiment that they wish to partake in.

 

Short positions working currently

Both Short positions are currently profitable. With the long weekend however, Monday might see a return of some short-term bullishness.

 

Goldman Sachs…like a rolling stone

Every now and then financial articles pop-up in the most unexpected places. This particular article traces Goldman Sachs history within the financial markets. Their participation within the commodities futures markets however contains some interesting research.

Essentially, Goldman Sachs was provided with a secret exemption letter allowing them [as speculators] to build up larger positions than the physical producers.

This directly contravened the controls put into place to prevent speculators [who are a necessary component] to exceed in dollar values the dollar values of producers, who need to hedge their production.

Rising commodity prices, driven by long only money in the form of Pension Funds etc are generally bad for an economy. Stock prices are generally perceived to be a positive when they rise. Rising commodity prices, due to speculation, distort [seriously] the originary factors of production in the production ladder.

Interesting article.

http://www.scribd.com/doc/16763183/TaibbiGoldmanSachs

 

flippe-floppe-duc

Aaaaaaaagh, Sell Short Gold @ $92.42