From the Trading Desk
European Central Bank President Mario Draghi said today that the ECB will broaden the range of assets purchased and extend its quantitative easing program until at least the first quarter of 2017. The program will maintain the monthly purchases of 60 billion euros and will expand to include regional and local government debt. Draghi noted that the central bank is “willing and able” to act beyond these measures if needed. While the ECB stuck to the course of quantitative easing, the market was expecting even looser policy from Europe’s central bank. As a result, the euro ended up gaining 4% against the USD on the day, an absolutely huge currency move. In other times, this should have caused gold and the precious complex to rip substantially higher. It is somewhat concerning that a 4% move in the euro only caused gold to move up 1%. Gold remains range bound with the momentum still clearly to the downside, even at these lower levels.
I can’t really say today was sell the news for gold moving higher from yesterday’s beat down, but i can make the case that Draghi not doing what was expected did some damage to the dollar and thus gold moved higher. Markets don’t like surprises and I have to give the ECB credit for this, but believe me they can switch on a dime next meeting and I think will. The Euro needed some rescuing. That was it. The dollar needed to cool off. That’s it.
Dollar got hammered today as that 100 resistance mark on the Dollar Index was still in play as the charts I have been showing you the last couple weeks have indicated.
I had a good discussion with someone challenging my deflation outlook recently. He made some good points and I did too and that’s how we try to discover truth. Unlike politicians that see only their parties view and cause divisiveness, I am always in the search for truth and when it comes to analyzing the markets I enjoy diving in head first and learning that for which I don’t know. I am not sure either of us convinced each other of their version of the truth but his position was that the falling prices in commodities does not indicate deflation but that we were still experiencing inflation and I didn’t agree. There were points made on both sides. Enjoy. (some other people chimed in as well).
Where is the massive credit contraction occurring? I don’t see it.
Kyle, we have gone from 367% Debt/GDP to 331% according to Ned Davis Research. That’s a pretty big contraction, but only buoyed by Fed orchestration (kicking can down road) of QE and naturally the $9 trillion thrown at the last crisis, some of which has been recouped with the higher markets. I wrote about the contraction in this article (see chart); http://seekingalpha.co…
I still don’t see any contraction in credit. Debt/GDP is a ratio and does not tell us anything in regards to this subject. The chart in the article you linked shows a $57 trillion increase in global debt since 2007. I’m not saying you are wrong – I just want to know where credit is contracting because I honestly can’t find it.
In that article you stated this:
“A simple look at a commodities chart will give us an idea of at least one aspect to deflation; resulting in lower prices.”
Surely you must understand that this is not correct? It has been INFLATION (credit expansion) that has resulted in cheap debt, overproduction and lower prices, not deflation.
Kyle, whether it is through default or elimination, a reduction of debt (credit) is a contraction. If I loan you money, I am extending you credit. If you default on that debt, I eat the loss (contraction). If you pay off the debt, it is a reduction of credit.
To your other point, credit expansion is inflationary. Commodities rode that expansion wave up and are now deflating.
Do you see this as wrong?
Yes, I know what contraction is. I am asking where you see it occurring in such massive amounts that it is offsetting the inflation. It was you who said this was happening, not me. All I am asking is where do you see this massive contraction that is offsetting the increase in credit, M2, etc.? Is there a chart or something you can show me?
I agree that credit expansion is inflationary. I disagree that “commodities are deflating.” Credit expansion drove consumption and thus higher commodity prices. Credit expansion is also what has now resulted in malinvestment and zombie companies remaining alive. Commodity producers are saturated with debt and need to continue producing in order to service that debt. The original consumption binge is no longer available, so overproduction is leading to lower commodity prices.
You see, in both cases it was INFLATION, or credit expansion, which drove commodity prices. First, credit expansion allowed the consumption of commodities. Secondly, credit expansion allowed the overproduction of commodities. We have not experienced deflation yet.
“We have not experienced deflation yet.”
Kyle, I showed you the chart of the contraction. This contraction is “buoyed” by QE and the other data I showed in that article. That data shows that $9 trillion has been thrown into the economy, keeping the contraction at bay. I see deflation in all the data which I track here (I don’t know how anyone can read it otherwise): http://bit.ly/1IiZCQ3
If you don’t see commodities deflating since 2011, I don’t know what to say. Prices have fallen in grains, oil, natural gas, copper, platinum, palladium, gold, silver. What do you call this decline in prices? You call this overproduction instead of deflation. What is your definition of deflation?
If a company has debt and can’t service it, and it defaults on debt, is that deflationary? If not, what do you call it?
What do I call this decline in prices? I call it a decline in prices…driven by inflation. Yes, that’s right. Credit expansion (inflation) has allowed many producers to remain alive via cheap debt when they’d have no business doing so in a free market. Inflation is the only reason they remain alive and are able to continue producing, which is driving commodity prices lower.
This is somewhat confusing to me because you defined deflation correctly in this very article, yet you’re now disagreeing with me about it. I’m not sure why.
The bottom line is that inflation distorts markets in various ways. Usually asset prices, commodities, and consumer prices rise AS A RESULT of inflation, but this is not always the case. Inflation/Deflation does not equal Rising Prices/Falling Prices. Prices do not inflate/deflate, money and credit do. Changes in prices are simply a side effect of inflation/deflation. We currently do not have deflation overall as the world’s 24/7 inflationary policy has not allowed deflation to occur.
Yes, debt defaults (contraction in credit) are deflationary, but the defaults are tiny compared to the increase in credit. If deflation was occurring, we’d see an overall contraction in the amount of leveraged loans, high-yield bonds, etc. That’s not happening…yet. Deflationary forces may very well win out in the end unless central banks want to get really crazy and take this game to the limit, which is quite possible.
Kyle said; I agree lower prices do not equal deflation but lower prices are the result of deflation (Austrian definition).
What do you attribute lower prices to?
Kyle’s point implies that a hike in rates would cut off overproduction and perhaps cause commodities to rally……..
Paully – Bingo. That is correct. While most assume higher rates would cause lower commodity prices, the opposite would happen after bad debt is liquidated and these zombie companies surviving on cheap debt are allowed to die.
Deflation USUALLY results in lower prices due to a reduction in the supply of money and credit. However, in the case of falling commodity prices over the past few years, the culprit has been INFLATION. I am not making a general statement about inflation and prices here. I am only talking about the recent decline in commodity prices over the past few years. In other instances in the past, inflation has often resulted in the opposite – it drove prices up as credit was used to consume/purchase assets. In this case, however, excessive credit expansion has been used to increase production of commodities to levels not in-line with true economic reality. The iron ore industry in Australia is a great example as well as fracking companies in the U.S.
It went like this….A) Credit used for a consumption binge (e.g. China building ghost cities); B) producers respond to this artificial signal and begin increasing production capacity, which can take years (e.g. mine development, infrastructure to transport commodities); C) commodity producers use cheap credit (result of central bank inflationary policy) to expand production in response to the artificial signal sent by all that consumption, but by the time projects are completed, this phony consumption has ended as it was never sustainable in the first place; D) producers have no choice but to produce anyway after spending billions (funded with debt) on projects aimed at increasing productive capacity; E) commodity prices declines as a result of an end to the artificial demand in combination with overproduction by commodity producers.
Kyle, how do you explain money velocity decline?
interesting viewpoint…..I’m certain there are many frackers who wouldn’t argue with you ….but I”m sure traditional thinking will argue…..wouldn’t it be something if higher rates actually helped us out of this mess……I’m hoping you and Doug continue this debate…..I see that oil is near to breaking 40 as we speak down a cool 4% ahead of Opec on Friday……..how long can a company like BP keep paying a dividend….kinder morgan down another 7% yielding near 10%……sfy! default……..it’s really ugh in the commod space…there’s got to be spillover to banking …..heck even the caddies are feeling the pinch…
So you’ve given up on the other discussion, Doug? I see.
Not sure why you’re asking me about velocity, but OK. That’s pretty basic. When one side of the ratio is dramatically changed, in this case the supply of money, it takes a lot of change on the other side of the ratio to offset it and keep velocity at its existing level. Such change on the other side of the ratio is not occurring, so velocity declines.
Keep in mind that the recovery in commodity prices wouldn’t happen instantly. We’d have to follow through with more rate hikes to even make a difference. 25-50 bps means absolutely nothing. Then when companies begin failing and are crying out for help, the politicians and central bank would need the guts to say “nope, sorry…can’t help you.” What are the chances of that happening? Although it’s worth noting that the free market is already overpowering the central planners in certain areas. Bond yields in the energy industry and on the worst of the worst junk debt are already shooting higher. Rolling the debt upon maturity is becoming quite difficult. We’ve likely reached “peak debt” and can’t take on much more.
Yes, higher rates would help us out of this mess just like withdrawal from drugs and rehab help addicts. But on the path to good health, we have to endure a lot of pain. There is no way around that. And I mean serious pain, like admitting we can’t pay social security and medicare obligations or even one cent of the national debt. History tells us that politicians do pretty much whatever is necessary to keep their jobs, so what are the chances they stand by and do nothing while watching this house of cards fall? I’ll take the opposite side of that bet. They’re more likely to do something even dumber to make the situation worse.
Kyle, I start conversations with a basic principle of understanding what they think the definition is before moving forward because I have had too many of these discussions where we just go in circles and I don’t have time for that. Haven’t given up at all Kyle, I ask you questions to understand your viewpoint. What’s wrong with that?
You said; “What do I call this decline in prices? I call it a decline in prices…driven by inflation. Yes, that’s right. Credit expansion (inflation) has allowed many producers to remain alive via cheap debt when they’d have no business doing so in a free market. Inflation is the only reason they remain alive and are able to continue producing, which is driving commodity prices lower”
“excessive credit expansion has been used to increase production of commodities to levels not in-line with true economic reality. The iron ore industry in Australia is a great example as well as fracking companies in the U.S.”
“Changes in prices are simply a side effect of inflation/deflation. We currently do not have deflation overall as the world’s 24/7 inflationary policy has not allowed deflation to occur.”
Are commodity producers increasing production now or cutting back?
What is this “side effect” of deflation then that you speak of that is causing prices in commodities to fall?
“What is this “side effect” of deflation then that you speak of that is causing prices in commodities to fall?”
In the case of commodities, lower prices are currently not the side effect of deflation but rather inflation, as I have been repeatedly saying. By side effect, I mean that the EFFECT or RESULT of inflation/deflation can be a change in prices. Prices themselves are not inflated or deflated. It is money and credit that are inflated/deflated. Manipulating the quantity of money/credit and the price of money (aka interest rates) has consequences that are not always easy to predict. Inflation, the go-to tool of central bankers, distorts market signals and changes the behavior of those in the marketplace.
Good discussion with Kyle.
I’m no economist, but I know what credit expansion directly caused here – inflation.
During Australia’s mining boom, prices were rising on anything related to the mining industry. Companies & individuals were having a great time
The result, & the problem, was a country on a “two speed” economy, one based on mining – with all related costs going to the moon. wages, real estate, specialised tooling, plant etc.
However, at the same time, the majority of the country was experiencing moderate growth.
Not cashed up and unable to compete for the same inflated goods and services that were affordable within the mining economy.
Deflation is now everywhere here. The same miners, if they even have a job, have had to renegotiate their salary down. Here in Queensland my neighbour drills for artesian water in support of mining operations. He has gone from earning AUD $250K three years ago, to $82K now!
My neighbour’s associated costs & debts associated with expanding his business during the boom times are still very real and have yet to be paid down somehow!
Real estate in the periphery towns has gone into free-fall. Those same miners that were buying up multiple properties in the cities, pricing locals out of the market, are nervous and paying down debt as fast as possible.
My take on this is that when people are flush with cash, everything is pricey. But when nobody’s got any money, all of a sudden its dirt cheap. Especially the luxury items.
Actually the Chinese presence here, buying anything not nailed down is likely responsible for us not taking a nose-dive – yet.
How does the saying go? – “The cure for high prices are high prices”
Hi Jellac, thanks for chiming in. Chinese do seem to be propping up most markets, especially real estate with their new billionaire class. I have heard that some selling is afoot.
I do think hoarding is going on, which is also deflationary and something the Fed doesn’t want. Banks are hoarding. Consumers savings rate higher. Debt being cut. I don’t see this as anything but deflationary.
“By side effect, I mean that the EFFECT or RESULT of inflation/deflation can be a change in prices. Prices themselves are not inflated or deflated. It is money and credit that are inflated/deflated. Manipulating the quantity of money/credit and the price of money (aka interest rates) has consequences that are not always easy to predict. Inflation, the go-to tool of central bankers, distorts market signals and changes the behavior of those in the marketplace.”
Money supply (M2) is off the charts. Inflationary. Check.
QE and Operation Twist. Inflationary. Check.
Banks hoarding reserves is not inflationary and by default deflationary. Check.
Money velocity declining; Deflationary. Check – How you don’t include this or question its relevancy I don’t understand. “Money velocity decreases when fewer transactions are being made; therefore the economy is likely to shrink.” What Does Money Velocity Tell Us about Low Inflation in the U.S.? http://bit.ly/1X6GPVg
Example; “During the first and second quarters of 2014, the velocity of the monetary base2 was at 4.4, its slowest pace on record. This means that every dollar in the monetary base was spent only 4.4 times in the economy during the past year, down from 17.2 just prior to the recession. This implies that the unprecedented monetary base increase driven by the Fed’s large money injections through its large-scale asset purchase programs has failed to cause at least a one-for-one proportional increase in nominal GDP. Thus, it is precisely the sharp decline in velocity that has offset the sharp increase in money supply, leading to the almost no change in nominal GDP (either P or Q). So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? The answer lies in the private sector’s dramatic increase in their willingness to hoard money instead of spend it. Such an unprecedented increase in money demand has slowed down the velocity of money.” and “The issue has to do with the velocity of money, which has never been constant, as can be seen in the figure below . If for some reason the money velocity declines rapidly during an expansionary monetary policy period, it can offset the increase in money supply and even lead to deflation instead of inflation.”
Professor Carmen Reinhart, Harvard Univeristy kennedy School of Government; Absent quantitative easing in the United States, Europe, and Japan, those economies would have been mired in a deflationary post-crisis landscape akin to that of the 1930s. Early in that terrible decade, deflation became a reality for nearly all countries and for all of the advanced economies. In the last two years, at least six of the advanced economies – and as many as eight – have been coping with deflation. At the end of the day, the US Federal Reserve will base its interest-rate decisions primarily on domestic considerations. While there is more than the usual degree of uncertainty regarding the magnitude of America’s output gap since the financial crisis, there is comparatively less ambiguity now that domestic inflation is subdued. The rest of the world shares that benign inflation environment.
Regarding the large producers you are mentioning, there are some that are struggling to even pay dividends after 80 years (one example in last week) and others that their AISC is more than the price of the metal. They are cutting production, laying off, closing mines.
Not trying to argue with you Kyle, but if I were to sum up why you see inflation, it is because we are still increasing the credit amount, and I do agree with this and at the same time have more deflation ahead of us. I just view the commodities as leading the way and I think I have made the case for this, but will give you the point of the actual credit not yet declining, but the ratio is, which is what I was concentrating on.
“if I were to sum up why you see inflation, it is because we are still increasing the credit amount, and I do agree with this and at the same time have more deflation ahead of us.”
There ya go. See, after all this, we actually agree. You’re making it way too complicated. There are certainly deflationary forces that are being offset and then some by inflationary policy. Therefore, we do not have deflation…yet.
That’s fine. I am willing to discuss anything. I was just wondering how and why “velocity” became part of the discussion, that’s all. No problem, obviously.
“Are commodity producers increasing production now or cutting back?”
There are hundreds of companies that produce/sell commodities, so I cannot make a blanket statement. However, many of the large producers are either keeping production constant or still increasing it. This has been going on for years already, and we are now way beyond the point of increasing capital expenditures to further increase productive capacity. Capex is being cut now. However, some projects that took years to complete are just now coming online, and thus production will increase in those instances as the debt used to fund those projects needs to be serviced with cash flow.
As an added bonus, the large commodity producers like to keep production levels high in order to gain market share by putting the little guys out of business if possible. It’s a game of chicken – everyone knows production needs to be curtailed, but no one wants to be the one to actually do it. Look at all the U.S. coal companies that have gone bankrupt. Many of them made acquisitions at the precise top of the metallurgical coal market and couldn’t afford to cut back on production because their debt levels were insanely high.
Bottom line: We are mostly past the point of increasing production. We are now at the stage in which massive production cuts need to be made, but no one will actually do it until they have no other choice. By that I mean when the commodity sales price is actually less than the cash cost of producing it.
See reply above. thanks.
excellent commentary Kyle and Doug, despite your differences you bring to light some key points….. I wonder if Mrs. Yellen has had this conversation with her advisors…..the one question I pull from this is regarding V. If we’re agreeing that M2 is hoarded by banks then how/why are shale and iron ore producers able to continue to ramp production? (perhaps it’s an “institutional thing”) ….Again the problem seems to me that the public is left out of the equation. I suppose the Fed would say the public “was” able to “use” the stock market for returns…..I still think the spread between libor and prime is too wide….In any event, the free market wins out i suppose……it’s a lot to digest
I just love this article, the theories, and comments/replies.
My wife just keeps it simple. She goes to Costco, Publix, Whole Food Markets, etic and cherry picks the sales. She watches the price of staples go up and up. Are you paying less for groceries than you did ten years ago?
She ran her station wagon into the ground. We shopped for a late model used car. Did we pay more for the car than we did tens years ago? Of course! We stopped at the gas pump and filled it up. The gas was a buck cheaper than it was a year ago but still close to 2 dollars. Oil hit 40 bucks a barrel about what it was 10 years ago, BUT price of gas was half as much as today.
She has a BS in math from Ohio State and masters in math education from Auburn. I told her about this article on deflation. She just laughed and wanted to know where to shop for deflated staples!
Jason – It is even worse than that. If you are seeing price increases, it usually means package sizes have been shrunk and every other trick has already been used before finally raising the price. But it actually gets even worse…even stable prices can be a harmful effect of inflation. In a healthy economy, goods and services are abundant and prices go down. If prices are staying the same, we are being robbed of the benefit of falling prices due to inflationary policy.
Jason, look at any commodities chart and the prices have fallen for 5 straight years. For those long, that’s not a laughing matter, especially if they own gold.
What you are confusing is retail prices with commodity prices. They are not the same. They each have their own supply/demand/owner idiosyncrasies.
Food prices are propped up by the record number of people on SNAP (built in clients thanks to the government).
Health care prices propped up by government paying the bills for many (medicare, medicaid, fraud, etc.)
College tuition higher because govt. guarantees the payment (on loans) to the colleges who continue to raise tuition.
Prices of TV’s, computers, etc. where there is a free market are falling in price. Some prices for other things, because of higher demand, are higher.
We have farmland in Illinois. Not getting what we used to for the grain.
Educated people shouldn’t be so ignorant about deflation.It doesn’t mean prices are lower. Virtually all the canned goods in the grocery store are about 3X more than they were 5 years ago. The price of gasoline is the ONLY thing that you get the same quality and a better price on .For now,soon that will bite us in the butt I’m sure.
Doug Eberhardt is a 28 year financial services veteran and precious metals broker selling gold and silver at 1% over wholesale cost. Doug has written a book to help investors understand how gold and silver fit into a diversified portfolio, how to buy gold and silver, and what metals to buy. The book; “Buy Gold and Silver Safely” is available by clicking here Contact phone number for Buy Gold and Silver Safely is 888-604-6534
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