Dollar Bull

The above chart shows previous support which is my near-term tartget around 86. That area will be the test. If we break decisively ABOVE that level a multi-year USD bull market will be confirmed. I would rate this potential right now around 50%, but rising every day. A multi-year bull market in the USD would be what few expect and would fit in with another thesis of mine. That this bubble was almost twice as large in price as the 1920's bubble, so we will see a collapse at least twice as great. If not in price, then in time. Thus, a 2015 low in stocks would fit with a long term dollar rally. This is premature speculation. But the longer the US Fed fights the trend, the longer it will take to play out. They could have forced us to take our medicine a year ago, but instead tried pulling rabbits out of a hat. Someday, they will no longer have any rabbits. But it seems likely that they will continue to fight the trend. That is what their paymasters the bankers will insist upon. Until the people stand up, and then they will have to pay off the people. I don't think the populism will work out much better. So expect a long, drawn out decline, that will stair step its way lower, until the capitulation point is reached. That will be 2013-2014 for real estate and then shortly thereafter for equities. For now, what the dollar, that is the key.

Real Estate Downfall

In case you have not seen this hilarious parody of the Real Estate Bubble, through the eyes of Downfall's Hitler, enjoy!

Warning! If you have been a victim of the real estate bubble, this might be too painful.
Acknowledgement to athebeach.blogspot.com

Argentina vs USA

I just finished reading the Wikipedia entry for Argentina's economic history. As with all of the Wikipedia entries, it is a hit and miss proposition, but it serves the purpose of giving an overview of the nation's economic history in five minutes. One of the classic lines is : "During the 1990s Argentina's financial system was consolidated and strengthened." Yet, somehow the same financial system blew up in spectacular fashion between 1999-2002. Hmmmm.

The real purpose of this post is to compare and contrast the nations of Argentina and the US. First, the US has maintained the world reserve currency for the last 75 years or so. Argentina has never nor could never even remotely fantasize about having the world use its currency as a reserve currency. The US has relatively low and stable inflation, occasionally experiencing deflation, with the worst inflation rate reaching the high teens for a short period of time. Argentina averaged 200% plus annual inflation for two decades, yes DECADES. Inflation seems to be heavily ingrained in the financial DNA of this beleaguered nation. The Argentine economy is consistently imbalanced. Whether trade balance, budget balance or economic industry imbalances caused by nationalizations and privatizations, serious economic imbalances are the norm in Argentina. Yet, due to a civilized and educated populace, they have still achieved economic growth overall. It has been uneven, messy, painful and largely criminal, but it has still been growth. The modern US economy does bear some resemblance to the Argentine model (although the British model of 100 years ago is probably a closer model). But the largest difference is the debt holdings of the two countries. Argentine debt has historically been denominated in US Dollars, so in a sense, the US is responsible for much of the trouble in Argentina financial circles ( more precisely the US banks are responsible). The US debt is virtually all denominated in our own currency which very fortunately, is the world reserve currency, backed by nothing. So we can print it at our very own whim, whenever necessary. For this reason, the Argentine situation seems unlikely to apply to the US, specifically since although the present administration is bent upon spending money it does not have in tremendous amounts, a rapid adjustment of the currency value is unlikely because virtually all other currencies are equally despised. This does not mean that double digit or chronically high single digit inflation numbers will not be likely in the years ahead, we should be highly skeptical of "hyperinflation" predictions for the US economy. While our problems are massive, in short, we are not Argentina.

Dynamics of Monetizing

The problem with most people, myself included, is that we think statically. For example, I might say "If I save my money some day I will be able to afford to buy a vacation home for cash!" But the world is not a static place, especially these days. My savings may be eroded by inflation or taxes or both or the price of a vacation home may escalate out of reach due to appreciation or taxes or both.

Such is the thinking of those who are convinced that the Fed's expansion of its balance sheet is inflationary. While I don't like Ben Bernanke or his policies and would not trust him as far as I toss a nickel underhand, in a sense he deserves credit for the plan to buy MBS. There are a few dynamics which could work out here. The first is if he is successful in reflating the economy and the asset prices of the houses backing these mortgage securities rises, then these securities could largely be money good and at least to a large extent, be paid back. In this sense this monetary expansion would largely be self-correcting. As these mortgage securities are retired, the excess reserves would be drained from the system, similar to a repo transaction, albeit with a much larger time horizon and of course, without the guaranteed repurchase. If this scenario actually plays out, then one should expect the largest impact of these purchases to be felt up front, with declining effects as these securities mature and are retired.

Now, the real risk in this dynamic is that these purchases are not limited and will be continued beyond their stated expiration. This should not be discounted as the program has already been extended once and political pressures could easily cause it to be extended again. This is the real risk of inflation that we could be facing. But it would require a continued commitment to purchase large quantities of these securities, possibly other junk as well. And the nature of Ponzi finance is such that ever increasing quantities would need to be created and purchased. While this scheme would not be long-term sustainable, it could provide years of positive inflation before leading to a bust of epic proportions. So who would create these securities? And what size would need to be purchased? There may actually be enough of these securities for the Fed to monetize for a few years yet as there is probably $50T plus of debt lying around the globe waiting to go bad. But the $1.2T is really a drop in the bucket. In a $15T US economy, with $150T in US dollars floating around the world with the aforementioned debt, all the Fed may have done would have been to pump up the system by 1-2%. (Yeah, I know all about the multiplier effect, but that is not coming into play, at least not yet, because the private sector is retiring debt not expanding debt.) So the result is basically a wash. Now it is not impossible to see $150 oil, 15,000 on the Dow, Miami condos selling for $500k or more again, but it will not be easy and it will take a helluva lot more than $1.2T. Try $10T or $20T over the next 3-5 years. Although, Helicopter Ben is crazy, is he really that crazy? And moreover, would the rest of us sit by silently and watch such insanity? We are already close to the point where new debt is actually destructive as the service costs eat up a prohibitive amount of income. A gradual scaling back of MBS purchases by the Fed could lead to a slow collapse, while a rapid expansion would likely eventually lead to a violent failure of epic proportions. While it is hard to envision the latter, we must always be aware and on the look out.

Tale of Two Timeframes

How severe has this recession been? Severe. But there have been more severe events in the US economy in the last 100 years and the country didn't fall apart. Let's look at two graphs.

First, industrial production for the last 10 years:

Wow! That's a sharp reversal! And we have only had a bounce so far. At this rate, it will take the next decade to get back to where we were. And now for the last 100+ years:

Notice the volatile movements in the 30's and 40's. Understandable. But more subtly, notice the rate of change is declining. Ever so slightly, but it appears to have peaked in the early 70's. Also, notice the prevalence of recessions in the 10's and 20's. It seems to be almost half of the time the economy was in recession! Some will say that the Fed and government have learned and are able to smooth out the economic cycle. Others might say that the economy was a self-correcting system back then, with negative feedback creating a more stable economy. Which one you believe has vastly different implications for the future. Of course, this graph may reflect nothing more than inflation. Which could be ominous if this slowing in industrial production continues.