[Jotapay]

What is the world is going on? Corn, oil, silver and gold are nose diving. The dollar index is shooting up?

This doesn't make much sense right now since much of the US economy is teetering and our debt and inflation is literally skyrocketing.

Thoughts?

[firestarter]

It's what happens in a deflationary credit collapse.

[Carlhole]

This is just how markets act.

A bunch of money had found its way into commodities as a hedge against inflation. The Fed has been letting the dollar devalue by keeping interest rates down. Recently, the dollar has bounced higher and the frenetic pace of the global economy has slackened in a response to high energy prices.

Since burgeoning demand for oil has been a salient characteristic of global markets, much of this money found its way into crude and natural gas. But this huge run-up is itself unsustainable unless the world economy keeps on keeping on.

Right now, we see fears that the world economy will slow dramatically. So some of money boosting crude and other commodities has fled those sectors as investors have taken profits or sought safer havens. Crude will probably fall to the 100 - $110 level but its anybody's guess.

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[frankthetank]

Calm before the storm...

[evilgenius]

$this->bbcode_second_pass_quote('firestarter', 'I')t's what happens in a deflationary credit collapse.

[Twilight]

The commodities dip is due to renewed dollar strength, less money entering circulation and more being destroyed servicing debt and defaults.

An example of the deflationary component from the front lines: a few months ago builders' merchants were warning their customers of price hikes in common materials such as cement, concrete, rebar and steel sections for the coming months and next year, even as their customers were slamming project pipelines shut, announcing massive layoffs, cutting back what few fixed assets they had, attempting to refinance debt and focusing on completing far-advanced projects before the buyers disappear.

Here is an example:

8 May: Plans have been approved for 250 new houses, shops and a church on the outskirts of Westhill. Aberdeenshire councillors have unanimously given builder Stewart Milne's multi million pound application the go-ahead.

21 July: The Stewart Milne Group said about 289 jobs could be lost, which is approximately 20% of its UK workforce.

Think those price increases will hold? Maybe for a time, but it is a question of inertia, because next year the residential and commercial buyers will not be there. Infrastructure and government will, and you could be forgiven for failing to notice what's happening outside that comfortable cocoon, but no matter what its growth is, it will not act as a complete replacement.

I think very quickly those price increases will turn into discounts.

Now you might say aha, but even after a severe fall, energy prices will remain historically high. True, materials with high embedded energy content cost what they cost and it makes no sense to sell for less. But as volumes collapse, you are going to end up with liquidated inventories getting dumped and suppliers in competition where once they could barely keep up with orders and sold at a premium. In time, this will feed all the way back to the mills and then the mining companies themselves. Not to mention anyone with any sense has already been pricing ahead of rising energy, because just one experience is enough to teach the lesson that it hurts like hell when you do not. I can assure you it hurts.

And why is all this happening?

Because banks are lending people and companies less money on more onerous terms. That source of spending on industrial commodities is drying up. The state is not going to keep building half million square foot warehouses on city boundaries while others stand empty, nor will it start completing tower blocks once their concrete skeletons have stood undefended from the weather for a year.

Whatever printing the central banks are doing so far to cover the implosion of financial assets is currently not significant enough to do much to compensate for the loss of the real source of inflation.

How bullish do you have to be to believe the ME Gulf, China and India will substantially replace the demand destruction that is about to take place in the West? Also, what is the prospect of banks lending yet more money for infrastructure there, when falling energy and commodity prices are reducing their income, hence safe debt load? Do you not think this might become a negative feedback loop as they wait and see what happens?

[erl]

The dollar's climb in the last couple of days may also be due to the conflict in South Ossetia.

Conflicts in certain areas of the world often seem to spark a "flight to safety" in currencies.

That has usually meant strength for the U.S. Dollar.

The dollar's rise in turn is driving down commodities.

[aflurry]

$this->bbcode_second_pass_quote('Jotapay', '
')Thoughts?

[Twilight]

Not always. Sometimes there is a change of paradigm. I think one is gathering enough strength to move the market, though it may do so next year. Right now is more likely a change of sentiment preceding the real fun.

[Jotapay]

$this->bbcode_second_pass_quote('Twilight', 'R')ight now is more likely a change of sentiment preceding the real fun.

[shady28]

Read Mises, an early 20th century economist, for what / why about deflationary forces (which is what the OP just described).

Credit is how monetary expansion occurs. When credit dries up, money becomes scarce. Scarce money is valuable money.

The more distant future (ie, 2+ years out) may still hold hyperinflation in store, most likely the result of federal policy makers caving to populist demand for relief from a deflationary spiral and simply printing money (they are not doing that yet, they are still pushing on the credit string).

That isn't where we are right now. We're in the initial phase of a deflationary spiral.

[DantesPeak]

I don't want to say I disagree with some of the well made points about deflation above, but I have some alternative explanations.

First, buying of US dollars by foreign central banks and funds has been very heavy these last few weeks. It's has not been unusual for this to occur when the US Treasury issues a large amount of bonds/bills. This is exactly what has happened lately. The amount of foreign buying is almost exactly the amount of new Treasury debt. This is no coincidence.

Second, the buying of dollars by foreign central banks is in the long run inflationary - not deflationary. Admittedly in the short run, people talk about an artifically made "rally". However foreign central banks create even more money to buy Treasuries - thereby adding to the world money supply.

Whether all this new money offsets the effects of economic deflation is open to debate, but so far, monetary inflation is way ahead of economic deflation.

Do any of you deflationists want make a figurative bet that commodity indexes will be lower at year end? I bet higher.

[Twilight]

$this->bbcode_second_pass_quote('DantesPeak', 'D')o any of you deflationists want make a figurative bet that commodity indexes will be lower at year end? I bet higher.

[shady28]

I have to disagree with the assertion that debt creation is outrunning debt collapse.

Consider that, just from housing, somewhere in the neighborhood of $2 trillion is suspected to be bad - above and beyond what has already been declared. Throw in the potential for 10+ trillion in debt to collapse if the current crises isn't stopped.

Indeed the federal government running a deficit continues to inject liquidity into markets via debt creation (aka, treasury bonds). There is nothing new here - what is new is that the credit markets are contracting faster than the federal government creates new debt. The $400 billion or so that the feds create in debt in a normal year has been eclipsed by the credit collapse now running into the trillions. Now they are talking about 800 billion in deficit spending for 2009. If we are talking about $2 trillion in credit gone bad for 2007-2008 (most of it in 2008), my guess is 2009 will wind up being much worse. It's like trying to put out a forest fire with a fire truck.

The only way the federal deficit spending would overcome the current bubble collapse would be to begin running multi trillion dollar deficts per year. If / when that happens, you might see a hyper-inflationary scenario. It's a lot more likely we will see government at all levels (state, local, fedeeral) begin to cut back spending. This will only feed the deflationary bubble and make dollars even more scarce.

The alternative is to ramp up debt expansion via government borrowing, which will only provide short term (perhaps a year or two) of relief, and then quickly hasten the demise of the dollar as the debt service load becomes unbearable. But by 'hasten' we would likely still be talking 5 or more years down the road.

What's happening is the classic economic cycle. Wikipedia has good info on monetary expansion :

http://en.wikipedia.org/wiki/United_Sta ... omparables

"When the expenses of the U.S. Government exceed the revenue collected, it issues new debt to cover the deficit. This debt typically takes the form of new issues of government bonds which are sold on the open market. However, the debt can also be monetized by which the Federal Reserve creates an entry on its books to credit the US Government for an amount equal to the dollar amount of the bonds the Federal Reserve is acquiring. The money created in this process not only includes the new dollars that came into existence just to purchase the bonds, but much more because this new money is now sitting in the form of checkbook money at the Federal Reserve. Under the scheme of Fractional Reserve Banking this new checkbook money is treated as an asset to lend against. Economists estimate the expansion of the money supply as being many times the amount of the initial money created with the exact amount being a function of what percentage of deposits banks must set aside as "reserves".[15][16]
The ultimate consequence of monetizing U.S. debt is that it expands the money supply which will tend to dilute the value of dollars already in circulation. Thus, expanding the pool of money puts downward pressure on the dollar, downward pressure on short-term interest rates (the banks have more to lend) and upward pressure on inflation. Typically this causes an inflationary boom that ends in a deflationary bust to complete the business cycle. Note that money supply expansion is not the only force at work in inflation or interest rates. United States Dollars are essentially a commodity on the world market and the value of the dollar at any given time is subject to the law of supply and demand. In recent years, the debt has soared and inflation has stayed relatively low in part because China has been willing to accumulate reserves denominated in U.S. Dollars. Currently, China holds over $1 trillion in dollar denominated assets (of which $330 billion are U.S. Treasury notes). In comparison, $1.4 trillion represents M1 or the "tight money supply" of U.S. Dollars which suggests that the value of the U.S. Dollar could change dramatically should China ever choose to divest itself of a large portion of those reserves."

[DantesPeak]

World money supply is growing by about $3 trillion or so per year, and accelerating. I'll be happy to discuss the possibility of deflation when I see money supply growth slow down. Granted there is a significant chance of a sudden and severe deflation panic, similar to those the US occasionally experienced before the Federal Reserve. But it is even more likely that world central banks will act to increase inflation to offset deflationary events. I am not saying they will succeed in the long run, but in the short run (2 to 10 years).


$this->bbcode_second_pass_quote('', '"')DRIVERS OF INFLATION #9
Excessive Money Supply Growth
by Monty Guild & Tony Danaher
Guild Investment Management, Inc.
July 3, 2008

... worldwide money supply is growing fast, and excess money chasing goods and services creates inflation. China, Russia, Persian Gulf countries, India, and Brazil are growing their money supply way above the rates the governments desire. In fact, world money supply growth is estimated at 13-14% over the last
12 months.

Countries that run current account deficits, such as the U.S., Britain, and others have substantial trade imbalances with countries running current account surpluses, such as China, Russia, Singapore, Norway, and the Persian Gulf oil producers. As money flows into the surplus countries as a result of their exports, the receiving country must sterilize the inflows of foreign currency. To do this, the surplus countries' central banks must print money in their own currency in an amount equal to the inflows of dollars, or pounds, or other currency. This results in an expansion of their money supply. Eventually, having increases in money supply that exceed increases in productivity leads to inflation as we discussed earlier.

When a country has a surplus and their currency is partially or completely pegged to the dollar (e.g. China, Saudi Arabia, and other Persian Gulf states), they are in a difficult position. They must raise the value of their currency and their interest rates if they want to solve their inflation problem. However, current account countries are slow to act in this manner because even though inflation is rising, their standard of living is rising faster due to their current account surplus and the wealth the country is accumulating. This inflation ends up in the feedback loop discussed in driver number nine, and is how currency sterilization activities by current account surplus countries lead to an increase in global inflation."

[cube]

$this->bbcode_second_pass_quote('Twilight', '')$this->bbcode_second_pass_quote('DantesPeak', 'D')o any of you deflationists want make a figurative bet that commodity indexes will be lower at year end? I bet higher.

[Twilight]

Alright. Q3 next year, I expect lower prices on commodities used heavily in building materials. Iron, steel, cement, no recovery in zinc, but I am specifically excluding copper. While not in this category, I also reckon lead will end up significantly lower. Consumption in the ME Gulf and China may hold up a little longer, but the North American and European markets are in decline and it will take a lot of pumping to compensate for a plain lack of buyers.

[firestarter]

James Turks explanation for dollar movement is similar to what you've proposed, Dantes Peak:

$this->bbcode_second_pass_quote('', '"')...When central banks intervene in the currency markets, they exchange their currency for dollars. Central banks then use the dollars they acquire to buy US government debt instruments so that they can earn interest on their money. The debt instruments central banks acquire are held in custody for them at the Federal Reserve, which reports this amount weekly.

On July 16, 2008 (the closest date of the weekly reports to the July 15th low in the Dollar Index), the Federal Reserve reported holding $2,349 billion of US government paper in custody for central banks. In its report released today, this amount had grown over the past three weeks to $2,401 billion, a 38.4% annual rate of growth. To put this phenomenally high growth rate into perspective, for the twelve months ending this past July 16th, assets in the Federal Reserve's custody account grew by 17.3%, which is less than one-half the growth rate experienced over the past three weeks.

So central banks were accumulating dollars over the past three weeks at a rate far above what one would expect as a result of the US trade deficit. The logical conclusion is that they were intervening in currency markets. They were buying dollars for the purpose of propping it up, to keep the dollar from falling off the edge of the cliff and doing so ignited a short covering rally, which is not too difficult to do given the leverage employed in the markets these days by hedge funds and others. So central banks pushed in one direction and funds and traders then stepped on board. In other words, central banks ignited the fuse of a bear market rally...."

[cube]

$this->bbcode_second_pass_quote('Twilight', 'A')lright. Q3 next year, I expect lower prices on commodities used heavily in building materials. Iron, steel, cement, no recovery in zinc, but I am specifically excluding copper. While not in this category, I also reckon lead will end up significantly lower.

[shady28]

$this->bbcode_second_pass_quote('cube', '')$this->bbcode_second_pass_quote('Twilight', 'A')lright. Q3 next year, I expect lower prices on commodities used heavily in building materials. Iron, steel, cement, no recovery in zinc, but I am specifically excluding copper. While not in this category, I also reckon lead will end up significantly lower.