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Thursday, January 15, 2009 11:23 AM


Social Mood Will Define The Future


Boomers have known only inflationary or reflationary conditions for most, if not all of their conscious lives. Here is the pattern: Want, work, borrow, spend, enjoy, and worry about the bills tomorrow, as if tomorrow would never come.

Now tomorrow is dawning, the bills are due, and boomers are now entering end of life with a need to consume what they perceived would be a treasure chest of accumulated wealth that would allow them to sustain their inflationary lifestyles to life's end.

However, that wealth has now vanished in a giant deflationary two-step of collapsing home prices and a collapsing stock market. Note that those are symptoms of deflation not proof of it.

However, 15 out of 15 things one might expect to see happen during deflation are happening now, as detailed in Humpty Dumpty on Inflation.

Material living standards and associated expectations among even the lower working class and poor in the western nations have been raised to levels that will not likely be maintained during a secular deflationary crisis, let alone permit the lifestyles of the upper working class, professional middle class, and wealthy to remain intact.

Is Deflation A Government Choice?

Most still believe in the Fed's ability to inflate another bubble. They are mistaken. Instead I offer a Crash Course For Bernanke.

Greenspan had the wind of consumers' willingness and ability to go deeper in debt at his back. Bernanke has the wind of boomers fearing retirement in the midst of falling home prices and impaired bank balance sheets blowing stiffly in his face. There is no cure for what ails us other than time and price. And with the aforementioned attitude changes, the biggest, most reckless, global credit expansion experiment the world has ever seen is coming to an end. Central banks are powerless to do anything about it.
I know that in theory a determined government can always produce hyperinflation if it wants, I have heard that story 1000 times. If it was so simple in practice, however, yields would not be at 0%. Right now, the important thing to note is that even with massive "stimulus", thus far it's dwarfed by the implosion of credit and the trillions of dollars worth of writedowns and bankruptcies that are coming. Japan tried for years to combat deflation and failed.

Government Bonds A Good Bet

In contrast to the Bottom Callers In Junk, Hugh Hendry from Eclectica told CNBC, Government Bonds Still Best Bet.

The video is quite interesting and I recommend listening to it in entirety. With everyone up in arms over the so-called "bond bubble", Hendry has a much more pragmatic view, quite similar to mine. Here is a partial transcript of points Hendry made.

  • When it comes to treasuries I don't care about the next 30 years, I care about the next 30 months.
  • The Euro is a flawed mechanism and that spells trouble.
  • There is no money on the sidelines. We have had one of the most profound periods of wealth destruction in the last 12 month. Billionaires are throwing themselves in front of trains. Sideline cash is a myth.
  • Debt of all forms went from a generational low of 110% of GDP in 1974 to 360% of GDP recently. We have supersized everything. In 25 years it will be back at 110% of GDP. That has profound implications on valuations and asset classes. It puts a downward damper on everything.

I agree with Hendry's line of thinking, and even more so with all the bottom callers everywhere else. Would I want to buy treasuries for 30 years? Of course not. But that does not make them a good short either, not right now, and certainly not at 5% when many started. Ten year treasury yields are likely to stay under 5% for a long time to come.

Whether or not one considers treasuries to be in a bubble, should depend on a frame of reference. I would rather worry about the next two years than the 28 years that follow. Given that a deflationary environment that might last longer than most think, I see no reason to be shorting treasuries here except for a technical scalp. One could just as easily go long, given the wind is still at the back.

Multi-Generational Pendulum Shift In Attitudes

Most simply do not grasp the once in a multi-generational pendulum shift from risk taking to risk aversion. The credit bubble has burst and we are on the back side of Peak Credit.

As determined as Bernanke is, the best he will be able to do is drag things out for years, making zomibified banks in the process. Those who suggest The US Government Will Not Choose Deflation, simply have it wrong. Attitudes are the key and a secular change in attitudes from consumption to savings is now underway. And that attitude is what is going to define the deflationary years that follow, regardless of what government wants.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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