Bearish News

So, there are six asians and one american on an island together….

From 2007. Features Peter Schiff and Stephen Roach making calls that seem to be playing out today:

Schiff calls out the Fed, recommends buying foreign stocks.

They don’t wanna face the pain, they don’t want to deal with reality. If they can’t deal with it now, what makes us think they can deal with twice the pain in the future?

From Bloomberg:

Bank of America Corp. signed off on its government-assisted purchase of Merrill Lynch & Co. after U.S. regulators said the deal might boost the shares, e-mails from two executives showed. Instead, the stock collapsed.

“The chairman of the Federal Reserve indicated it would be structured in a manner such that BAC stock should go up when announced,” Chief Financial Officer Joe Price said in a Dec. 29 e-mail to executives of the Charlotte, North Carolina-based bank, including Chief Executive Officer Kenneth D. Lewis.

I take two things from this. First, it was Bank of America’s greed that drove them to accept the deal. Second, Bernanke is willing to do whatever, and I mean whatever, it takes to prop up the markets. They gave BofA $20b and guaranteed $118b in debt as part of the Merrill deal. It’s insane. And Bernanke thought it would boost BAC stock, and that was perfectly dandy.

Moral hazard, anyone? The fact that BAC ended up crashing is immaterial to me. BofA thought they were getting a sweetheart deal.

Unless somebody checks the Fed’s power, they will print as much as it takes to get out of this. When the current program ends, and everything starts deteriorating, what do you think they’re gonna do? Extend, expand, and print. They will say they didn’t see this downturn coming, that the economy was looking good (and why not, when they’re pumping trillions?). See Flaws in the Deflation Case for more on the general concept, though it is a little dated.

I can’t pass up the opportunity to post this picture by Jesse, even if Lewis may not have been under as much pressure as we thought at the time.

Most people will tell you gold’s inflation-adjusted all-time high is around $2300. $7150 is more accurate, according to John Williams, economist and editor of Shadowstats.com. He made that claim in an interview with Bloomberg:

If the methodologies of measuring inflation in 1980 had been kept intact, gold would have to hit $7,150 to be the equivalent of the 1980 record.

He said the government has understated the cost of living over the past two decades with adjustments in the way it measures the basket of goods and services monitored by the U.S. consumer price index, or CPI.

John Nadler, a senior trader for metals-dealer Kitco is skeptical about the gold run. He thinks that once the Fed starts tightening, the trend will reverse:

These wild calls for several-thousand-dollar gold are typical of times when gold goes into uncharted territory

The Fed will pull the interest-rate trigger and the Obama administration will, in addition, pull the tax-hike trigger before we get into any serious inflation. Once the man on the street gets in, the gold rally is likely over

Maybe the Fed actually will tighten when the time comes. But I’ll believe it only when I see it. I think more easing will happen before any tightening does. Fed liquidity is the only thing holding this market up. It largely depends on how long our creditors are willing to buy our bonds. If the Fed could get away with 10% inflation for a while, I think they do it in a heartbeat.

Economist Peter Bernholz is an expert on the subject of national hyperinflations. He has studied all the major cases of hyperinflation since 1980. His conclusion: The tipping point occurs when a government’s deficit exceeds 40% of its expenditures.

Guess what? The U.S. will hit the 40% mark in 2009:

Hayman Advisors provided a good summary of Bernholz’s research in their October letter (via FS):

There have been 28 episodes of hyperinflation of national economies in the 20th century, with 20 occurring after 1980. Peter Bernholz (Professor Emeritus of Economics in the Center for Economics and Business (WWZ) at the University of Basel, Switzerland) has spent his career examining the intertwined worlds of politics and economics with special attention given to money. In his most recent book, Monetary Regimes and Inflation: History, Economic and Political Relationships, Bernholz analyzes the 12 largest episodes of hyperinflations – all of which were caused by financing huge public budget deficits through money creation. His conclusion: the tipping point for hyperinflation occurs when the government’s deficit exceed 40% of its expenditures.

It’s important to note that the dollar does have some built-in protection as the world’s current reserve currency. That lets us get away with a higher debt-load than we should be able to. The question is, how much protection does that offer?

Also, how long will the dollar remain the world’s reserve currency? As Bloomberg noted, the world’s reserve banks are shifting away from US dollars. They’re shifting to currencies from countries with sound(er) monetary policy and less debt. We’re really in uncharted economic territory.

“It can’t happen here”

Hyperinflation in the US is hard to imagine. It could never happen to us… right? Well, fiat money has always collapsed eventually. I wonder if people in those countries ever saw it coming. My gut says the vast majority never saw it coming, but every case is unique.

Hedging Against Hyperinflation

If we are on the road to hyperinflation, you’ll definitely want to be in commodities. Stocks may do OK, but generally don’t keep up with inflation during hyperinflation. The exception would be commodity producers, such as gold miners. Foreign currency funds are another way to play it. I did a writeup on two mutual funds I like as inflation hedges here.

Jim Rogers likes agriculture plays better than precious metals: Cotton, sugar, etc. I’m mostly using metals to hedge against inflation, but Mr. Rogers’ suggestions certainly warrant a closer look.

If you’re looking to read more on the topic, Peter Bernholz’s research is featured in his new book Monetary Regimes and Inflation: History, Economic and Political Relationships. Looks interesting, I’ll probably pick one up with my next Amazon order.

Hat tip to Michael Panzner. He has an excellent writeup on the risks here.

From his Oct 10 column:

The truth is that the falling dollar is good news. For one thing, it’s mainly the result of rising confidence: the dollar rose at the height of the financial crisis as panicked investors sought safe haven in America, and it’s falling again now that the fear is subsiding.

The dollar is falling because of reckless economic policies like those Krugman advocates. Yet he actually thinks it’s falling because of confidence? It’s the exact opposite. Foreign banks are dumping dollars because they have no confidence in us. They’re switching to Euros, gold, and other currencies. New foreign reserves were 63% dollars in 1999. Today that number has fallen to 37% (see bottom).

We are losing our status as the world’s reserve, and it is most certainly not a good thing. Having the dollar as the world’s reserve brings extraordinary benefits. And we’re giving them all up, just to save bankers butts’ and attempt to stimulate our way to prosperity.

Consider this Bloomberg article: Dollar Reaches Breaking Point As Banks Shift Reserve.
Unless we change course immediately, the dollar will keep falling. Krugman doesn’t get it. He continues to advocate horrible fiscal policy. Excerpt from Bloomberg piece:

“Global central banks are getting more serious about diversification, whereas in the past they used to just talk about it,” said Steven Englander, a former Federal Reserve researcher who is now the chief U.S. currency strategist at Barclays in New York. “It looks like they are really backing away from the dollar.”

Sliding Share – The dollar’s 37 percent share of new reserves fell from about a 63 percent average since 1999. Englander concluded in a report that the trend “accelerated” in the third quarter. He said in an interview that “for the next couple of months, the forces are still in place” for continued diversification.