patrick.net

Not all commodities are created equal.

Industrial commodities are heading for crash landing soon right around when Chinese economy takes a nosedive, copper, zinc, mineral ore and all that good stuff. These minerals are not in real shortage once the world economy contracts and the building boom is over, and one can always recycle them.

The only hard commodity that can substitute currency is oil. 60% of the world's transportation is reliant on oil, and the cheap oil is gone. It is the basis of our lifestyle. Sure, oil will crash, but that will not be due to a contracting world economy, but a reasonable alternative, which is at least 20 years away.

Agricultural commodities are just riding on the back of oil and natural gas. Corn will crash when the US reverses its stupid "burn food for fuel policy", but there are some staple foods like soybeans that are facing true shortage, temporarily of course.

I think it is important to put commodities into several bins and rank them in terms of demand-and-supply situations.

OO, you are right about the fundamentals w.r.t. various commodities.

But in a secular deflationary scenario (which is what the quoted article seems to suggest), won't all the fundamentals be rendered moot until the markets adjust to dramatically lower liquidity levels?

On a related note, now that Buffett is open to providing a backstop for Muni ratings (and only Munis), I am thinking we will see monoline downgrades this week.

Monolines get downgraded. They declare bankruptcy. Buffett steps in and scoops up the Munis so they maintain AAA ratings. Monolines choke on the remaining toxic stuff. Buffett is the only game in town for AAA rating - so he gets *all* their future business. Brilliant. The man is a Genius.

Fed is not at its wit's end to drown the market with more liquidity. The current situation is like, the Fed lacks a tool to sprinkle money directly to the market because the primaries are hoarding the cash they just got. When Fed needs to bail out some financial institutions directly, that's one way of injecting liquidity. It also still has 3% to go for rate cutting. And the best tool of all is, increased government spending just like what we did in FDR time and what Japan did in the last 16 years, building roads to nowhere while taking down dams. Japan's Yen debt was something like 180% of its GDP, but it was all raised in Yen and that was sort of like our dollar debt situation. There is also no indication that Fed won't ramp up its open market operations again.

In the real world, we won't get straight inflation or straight deflation, we get a mix of both in different categories of things.

In a fiat world, lack of liquidity just doesn't exist. However, the government cannot *direct* where the liquidity goes. So even if it tries to reflate, the excess liquidity it injects into the system (which they will do so in an unprecedented way) has its own will, and most likely will not end up in categories that the government is trying to rescue.

Interesting that Adler points to SOMA funds reduced on evidence they were merely feeding further speculation. And the advent of TAF to get monies distributed broadly (repair of B/S, available to lend in the real economy).

Have we been mischaracterizing Mr. Bernanke? That chart says we have.

What are the implications of deflationary recession (on the evidence) for the various asset classes? Certainly Wall Street looks like a deer in the headlights.

Any time a new acronym is introduced my "pucker factor" increases. Such was the case with the introduction of TAF (Term Auction Facility) So are we to understand when they Fed opened up the window and nobody showed these latest brain farts were rolled out?

"We didn't think about the fact that removing reserves from the Primary Dealer accounts would trigger a mass liquidation in stocks. Next time we'll know."

Notice (as the article points out) these actions last July also seem to have coincided with the end of the bull market.

DinOR said:
Notice (as the article points out) these actions last July also seem to have coincided with the end of the bull market.

Also notice the cliff-dive on 2/Jan/08.

Wha' Happened?

A lot of folks here are betting on inflation and commodities, so what do you all think of an actual bubble-deflation at work?

I like it!!

The Fed reduces the monetary base (less loans, thus lower car and house prices)

GM restructures with buyouts (hopefully lower cost will lower car prices)

Hope for savers yet!

Cliff dive?.... hadn't noticed.

The first I'd heard about the TAF's someone here brought them up and I believe... the Fed memo was dated 27 DEC 07 (the thick of the holidays) and likely went without notice until everyone got back.

I'm just so unsure of the larger implications here? I've had a LOT of confirmation of OO's suspicions where commodities are concerned I'm just not sure I share his view that a great unraveling is necessarily in store for China? The reason I have reservations is b/c it's the... rough equivalent of saying our industrial revolution would have ended just 10 short years after it started?

Reading the article and comments, the impression I got was that the Fed was trying to move liquidity (SOMA, short term loans against long-term collateral of varying quality) from the Big20 primary dealers to the smaller banks (through TAF) that needed it more.

But TAF was created on 21. Dec 2007 (says Wikipedia), long after the credit problems started in July/Aug. That makes me think that the Fed had little to do with the August crunch, but that they indeed tried to engineer the flow of liquidity to bypass the Big20 and go directly to the smaller banks, because the big banks were not "doing their job" and helping out the smaller banks. To make an analogy, it is similar to the 1987 stock crash when the NYSE market makers would not answer the phone and fulfill their stated duty of providing liquidity and orderly trading, even when prices are, yes, falling.

Is it possible that the dive in the charts simply was because the big20 realized that the smaller banks were in trouble, withdrew their loans (etc), and returned the cash to the Fed? The Fed then tried to goad them into borrowing (and lending out) again by reducing the discount rate. After 3 more months of seeing that this did not work, they created the Term Auction Facility, and thereby allowed the smaller banks (etc) to go "Treasury Direct", so to speak, bypassing the big20 all the while giving the smaller banks a cloak of anonymity.

How does that sound? My main point is that the initial drop in liquidity was not caused by the Fed, but rather by a sudden rise in risk aversion among the primary dealers. The TAF was eventually instituted because the primary dealers were not dealing.

It's not a liquidity crisis.

It's a solvency crisis. Most of the major US banks are insolvent - they now have no reserves, all their current money on hand is from the TAF. Once the monolines are downgraded, it's all going to come out - which is why the monolines are such a big deal right now.

As for commodities, I don't know which ones will do well, but I know which ones are doomed: Silver and Platinum are going to go down by far more than many expect. Both are used in industry, and when that use drops... and that will probably take my favorite PM, gold, with it, but only for a while.

I expect gold to come back after a substantial drop, so I'm currently hoarding cash for a purchase when it drops.

I dunno if the Fed is aggressively destroying money, but money is aggressively being destroyed. That's for sure.

I'm broke - flat on my ass, broke. I'm personally responsible for destroying a little over $100k of good old USbucks. I'm also not earning. I myself, little old me, is depriving the economic machine of one hell of a lot of money! When I was earning it all blew right out again, I was one hardworking little economic motor. And that's gone now. As far as I can tell it's going to be gone forever. The rest of my life will be spent living on less than a grand a month, living frugally. I'm learning to play trumpet, hey maybe I can drink myself into an early grave like Bix Beiderbecke did. Sounds a lot better than taking a long time to rot working myself to death in some warehouse or cubicle.

Now, this is not about me, I just cite myself as an example. I'm willing to be when this is all done and the dust has settled, we'll find that the average AmeriCan't is in the hole about the same amount, about $100k. Easily. Between ARM and HELOC debt, car debt, lost their job and now working at CostCo and may lose that job next week, etc. Their spending will have to go way down - that's one hell of a lot of money that won't be circulating. People living in tent cities don't go out and buy new Volvos, and I'm willing to bet there are a lot of ex-middle-class people in the tent cities. And will be more.

So, my point is, money is being destroyed to the tune of about $100k per US worker, just about all adults. Does anyone think the Fed is even able to create that much money out of nowhere? When money's being created and kept in existence by its being spend, and circulated, around and around?

Atlas (the overworked american lumpenprole) is shrugging.

In other news, homes in Santa Clara which sold for $700k in the boom of '05 are now on the market for $550k. Homes in Boulder Creek are down from $600k to $350k - yow. It's picking up steam.

The reason I have reservations is b/c it’s the… rough equivalent of saying our industrial revolution would have ended just 10 short years after it started?

Xactly. When the U.S. and W. Europe clearly slide into the post-RE recession (assuming we haven't already), BRIC has plenty of untapped domestic "pent-up demand" to keep the commodities party going for decades to come. Despite all the bad economic news, gold, oil, LNG, copper, all *still* trading near all-time highs, and I doubt this trend will reverse anytime soon.

RE: main topic: I second OO. "Inflation is not a single variable", as Peter P often says. Most of us here still expect falling nominal prices in housing to some extent, despite all the Fed's and Congress's increasingly desperate efforts to "save" housing. I suspect they will achieve some success in their efforts, mainly by trying to inflate everything else. As far as that "withdraw billions of dollars" goes, does this look like the Fed is aggressively contracting the money supply?

And, yes, the Fed cannot precisely target where the money goes, and they also cannot also force people and businesses to borrow (pushing on a string). However, they do have *some* control. It's also important to point out that Congress has far more power than the Fed acting alone. I have to wonder if Congress won't have some future remedy for this new "conundrum", though. Something like issuing us all $100K REIC credit cards --only good for spending on overpriced McMansions, pergraniteel upgrades and the like.

Let's not kid ourselves here: the gub'ment still has plenty of ammo left to prop up asset prices, debase the dollar and punish savers.

blah blah blah

this is turning into a Roubini-fest...

yawn

more interesting to me is the inflation in airfare in the past 2 months... i used to easily find cheap airfare as recently as christmas week...now fares range $400-500 on routes that are usually $200-300 or so...

and the planes appear to be full if i trust the airlines' web sites...

:(

"$100K REIC credit cards" ok that was good.

Why play around!? WTH, make it... 200K.

Silver and Platinum are going to go down by far more than many expect. Both are used in industry, and when that use drops…

I especially see a long-term drop in silver due to the replacement of film-based photography with digital photography. There's huge amounts of silver still in the ground in the US - Idaho's "silver valley" produced over a Billion ounces of silver and there's still a lot left up there and in the Owyhee mountains.

Platinum will still see its use increase due to its use in cat cons.

Not silver advice. ;)

HARM, DinOR, OO

Is the current boom in China truly an "industrial revolution" in the way that the industrial revolution occurred in Great Britian / US / Germany. In one way, yes: poor agricultural workers are leaving their traditional homes and ways of life to work in dark, satanic mills.

But in most other ways, no: 200 years ago the creation of power loom resulted in a huge productivity gain in the creation of cloth. Railroads replaced horse drawn transport. Etc. Etc. -- I'm not going to give a lecture on economic history.

China's advantages appear to be: breathtakingly cheap and nearly unlimited supply of labor (by developed world standards), a willingness to despoil their environment (environmentalism is a luxury enjoyed by rich nations), vendor financing to its customers (remember Lucent, anyone), Communist party control of the means of production (resulting in party members and those with connections succeeding spectacularly), and a willingness to jail or execute those who try to upset the status quo.

Oh, and there's been a privitization of eduction and heath care as well, from what I've read (that is, you don't get any if you can't pay for it).

A great place to make cheap products cheaply: absolutely. An industrial revolution: hardly.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aue8imip6T3Q&refer=home

Rates on $100 million of bonds sold by the Port Authority of New York and New Jersey, with bidding run by Goldman, soared to 20 percent yesterday from 4.3 percent a week ago, according to data compiled by Bloomberg.

The auction failures provide new indication of Wall Street's unwillingness to commit capital amid $133 billion in credit losses and asset writedowns.

``It's the beginning of the end for the auction-rate market,'' said Matt Fabian, a senior analyst with Concord, Massachusetts-based Municipal Market Advisors. ``Banks have stopped supporting the market.''

I believe this is what is called an 'oh shit moment.'

I expect gold to come back after a substantial drop, so I’m currently hoarding cash for a purchase when it drops.

If you expect a drop, you can use options to hedge your holdings. There are option on gold futures as well as index options on XAU.

Not investment advice. Options are risky and are not suitable for all investors.

BRIC has plenty of untapped domestic “pent-up demand” to keep the commodities party going for decades to come.

I can't speak to Brazil, but Russia is a petro-power (which puts it in a different class). India is reliant almost entirely on the economies of the West, and you'll have difficulty finding anyone who says otherwise. As for China - besides the US and Europe, they trade with their Asian neighbors - but recent reports suggest that most of that trading is actually a big supply chain that ends in the West. Don't expect China to do well in the coming years - they're one recession away from street riots.

Despite all the bad economic news, gold, oil, LNG, copper, all *still* trading near all-time highs

Yeah, and stocks are still pretty high too. Proves only that there's tons of optimism still left in the market, not actual future demand.

“Inflation is not a single variable”, as Peter P often says.

Yeah, it is a constant: 2.00%. :-P

If you expect a drop, you can use options to hedge your holdings. There are option on gold futures as well as index options on XAU.

I tried to learn about options, and they made my head hurt. Thanks for the (non)advice, though.

Options are risky and are not suitable for all investors.

Indeed - that certainly includes me. You gotta watch those things like a hawk.

Instead, I'm also buying short ETFs, which are eminently more understandable, though their fees make them unsuitable for a longterm hold, they're a great way to bet the other way, as far as my non-expert mind can tell.

But mostly cash for the next few months.

Let’s not kid ourselves here: the gub’ment still has plenty of ammo left to prop up asset prices, debase the dollar and punish savers.

Out of curiousity, what "ammo" do they have now that they didn't have in the 30s? Do they have any "ammo" that Japan lacked? Honest question - I don't see any, but that doesn't mean it isn't there.

(And yes, I'm aware that in both cases, rates were foolishly raised going into their respective crisis. That one difference is a pretty thin reed to hang hopes on, isn't it?)

You gotta watch those things like a hawk.

Not necessarily. If you sell naked options, you will lose hair though.

Instead of buying short ETFs, have you consider selling ETFs short instead?

Not investment advice

Out of curiousity, what “ammo” do they have now that they didn’t have in the 30s? Do they have any “ammo” that Japan lacked?

Ruthlessness?

Ed S,

Thanks for the input. Perhaps my choice of terms wasn't ideal? I think there are dangers in assuming any event in the West will play out similar to what takes place in China. If we fail to become their "buyer of last resort" I have confidence they'll work on whatever comes next.

I no longer am "long China" but I don't have any desire in seeing them in some sort of death spiral?

more interesting to me is the inflation in airfare in the past 2 months… i used to easily find cheap airfare as recently as christmas week…now fares range $400-500 on routes that are usually $200-300 or so…

I imagine this is the pass-through effect of oil prices making it to the airline industry, which of course is highly sensitive to jet fuel prices. So who says inflation is "contained?" Oh yeah, that would be the dynamic duo of Bernanke and Paulson.

and the planes appear to be full if i trust the airlines’ web sites…

The airlines have been implementing severe cost-reduction strategies, like cutting back on the number of flights to fill each flight more. The other lame example is United charging $25 for every extra check-in bag beyond one bag.

I am NOT bullish on oil. The coming recession will knock down oil prices.

The SoCal January DQ numbers are out, and there's more ugliness:

http://www.dqnews.com/RRSCA0208.shtm

For entertainment, check out Marshall Prentice's spin this time:

"We don't know how much of this downturn is driven by market fundamentals, and how much is due to turmoil in the lending industry. The market has been sending mixed signals since August, and it's virtually impossible to see trends and make predictions. Our sense is that quite a bit of activity is on hold, we just don't know how long it can be kept on hold," said Marshall Prentice, DataQuick president.

That's right, LOTS and LOTS of PENT UP DEMAND. We just can't keep holding off that demand much longer - it's ready to bust out!

netdance,

in the 1930s, USD is a gold-backed currency. Their hands were tied.

Debasing the USD is the path of least resistance for a government and a nation deeply in debt. Technically, we will NEVER be able to get out of debt if USD retains its purchasing power. So let's not have any fantasy about USD retaining its buying power if we just shore up our dollars in the bank earning almost no risk 3% (so far) Fed rate. It ain't gonna happen.

Japan lacked ammo because it doesn't have a world reserve currency. It is also a saver nation with prudent consumers. The culture is similar to China, which has a problem stimulating internal consumption despite the huge base of savings. Asians like the count their wealth instead of spending it.

You don't want the Japanese-style deflation either. Wage income and passive income dropped faster than housing price, because jobs disappeared faster, and banking interest went negative. Savers are CHARGED money if they leave their savings with the bank, it happened in Hong Kong as well. Yes, housing price went for a long dive, but your wealth also shrinks along with everything else, because equity market tanked, Japanese Treasury yielded 0.2%, birth rate went sharply down and there was no money to be made by anyone.

"tons of optimism still left in the market" Wow! Really?

Wouldn't be anyone "I" know. Things have shifted. I think the whole "bears-bulls" thing is now outdated altogether. (Whether you just have a 401K at work) or are in the primary mkt. most of us have at best been "cau...tiously optimistic" (yet ready to pull the plug at a moment's notice!)

We were even cau...tiously optimistic when our pockets were being lined! Great. We had 40% returns last year! Does this mean you're bullish? Oh HELL... no.

How many of you still know people out there touting DOW 30K!?

I'm stilling trying to wrap my head around that chart. I think I misinterpreted the linked article, comments and charts the first time around. Let me try again.

The big drop in SOMA, matched by a nearly as big increase in TAF, all happened in the Dec-Jan 2007-2008 timeframe. That means that the big20 primary dealers returned their borrowings to the Fed, and then the Fed promptly lent it out again through the other teller window. Whether the TAF money went to the big20 or then directly to smaller banks is hard to say, and I suspect there is no data available because of the anonymity offered by TAF. It *may* have been that primary dealers were very happy to return the money and let the Fed assume the risk more directly.

Going back to August, there is a noticeable drop in the SOMA balance around the time of the credit crunch, indicating that big20 banks were returning money, whether from reserves or from called-back credit to others. But I don't see any Fed action *causing* the August crunch, except of course for the previous excessive sloppiness under Greenspan finally catching up with us as a whole.

DinOR, would be interested in your take on this interpretation. Am I getting closer?

DinOR,

Didn't mean it to sound like an attack; it wasn't meant to be. I don't know what's going to happen to China or BRI(c) -- I'm at the far end of the information food chain (i.e. msm and blogs).

It's just that there's so much apparent wonderment about China that I think that we need to be a bit skeptical. There's so much of it: China's going to build cars! China launched a rocket! China is building a tall building!

Without a doubt, parts of China are entering the 20th century. But most of what they are doing and accomplishing has been done before -- they just do it cheaply (see earlier post for reasons). A place to make money: you bet. An unstoppable world power ready to overwhelm? I don't know (and will probably be dead by the time that question is answered).

Well, China is a misanthropist's nightmare.

It is understandable that China is a huge market because it has literally over one billion of willing consumers.

I am not a believer of larger markets. I prefer niche markets. China is already attracting too much competitions.

I don't think the chart indicated that the FED is voluntarily reducing the monetary base. The FED's intention cannot be clearer, inflate.

It was merely an indication that FED's policy of sprinkling money around got stuck in the pipeline, because for some reasons the banks didn't want it. Don't worry, FED will go back and re-hash another mechanism to get everybody take the money.

Ed S,

I hope you're around... well around long enough to see all the things you WANT yo see! :)

No I didn't take it as a confrontation at all. Like you, we've been told since we were kids that China will have this great awakening and it will be wonderful (or horrifying) to witness! (Personally.. I'll take wonderful)

Hey and don't sell the blogs short. Yesterday when Hank spoke he took great pains to articulate that "Project Lifedone" (I mean LifeLINE damn'it) would *not be extended to "investors and speculators". Well where in the hell did he get the idea that was a priority to anyone?