Friday, May 16, 2008

Inflation primers: Pumpkins and Mice

At any point before or after reading this, please don't google "runaway inflation expectation" because you will get a bunch of people trying to sell you silver.

What you need to do is dust off your old common sense and a small macro econ book and start thinking.

1. First look at the data: What Treasury bond pays ENOUGH to cover inflation?

Hint: None.

2. So where are the bond vigilantes?

Answer: They don't wanna stand in the way of the crowd.

As Walmart pays US$ to the chinese subcontractors, the Chinese subcontractors must recycle the profit back into the currency that has the most liquid investments. Hint: What Treasury? :D

3. So will a recession fix the problem?
Not necessarily, "investment thesis" may stand in the way. Read what Warren Buffett has to say about it:

Buffett: "I don't think there's a bubble in agricultural commodities like wheat, corn and soybeans (I disagree, but let's go on). But in metals and oil there's been a terrific [price] move. It's like most trends: At the beginning, it's driven by fundamentals, then speculation takes over. As the old saying goes, what the wise man does in the beginning, fools do in the end. With any asset class that has a big move, first the fundamentals attract speculation, then the speculation becomes dominant.
Once a price history develops, and people hear that their neighbor made a lot of money on something, that impulse takes over, and we're seeing that in commodities and housing...Orgies tend to be wildest toward the end. It's like being Cinderella at the ball. You know that at midnight everything's going to turn back to pumpkins & mice. But you look around and say, 'one more dance,' and so does everyone else. The party does get to be more fun -- and besides, there are no clocks on the wall. And then suddenly the clock strikes 12, and everything turns back to pumpkins and mice."

and of course from yesterday, the issue of "paper/electronic commodities":

Washington, DC - The Senate today unanimously approved a measure offered by U.S. Senators Dianne Feinstein (D-Calif.), Carl Levin (D-Mich.), and Olympia Snowe (R-Maine) to close the "Enron Loophole." Since 2000, this loophole has exempted electronic energy markets for large traders from government oversight. The measure was approved as part of the reauthorization of the Commodity Futures Modernization Act.
The legislation would increase federal oversight authority to detect and prevent manipulation in U.S. electronic energy markets, create an audit trail, and increase transparency. The measure includes language to reauthorize the Commodity Futures Trading Commission (CFTC).

4. What happened if there CONTINUES to be runaway expectation of inflation, at the time when the government maintained through the CPI that inflation is very much under control?

Very tough question with and I am not willing to show my cards.

1970s spiral happened because policy could never caught up with the ways workers were frontrunning inflation by asking more money, and caused more inflation in turns. These days they say they can layoff everyone and ship the work to Chindia. Or can they?

This is where the entire confidence game is played, by various theories propagated by hedgefunds, but usually falls under the category called "Decoupling Theory".

The answer is clear to me from comparing a) GDP sizes, b) future expected growth, and c)direction of trade/imbalance. But I will let you decide for yourselves why you should go one way or the other, so that I don't deny the Devil their due when it comes to collect their well deserved human sacrifices. Good luck.


D said...


MTGSPY said...

I am comparing what I wrote:

"1970s spiral happened because policy could never caught up with the ways workers were frontrunning inflation by asking more money, and caused more inflation in turns. These days they say they can layoff everyone and ship the work to Chindia. Or can they?"

and a headline out of India Times

"Ten to 15 years ago workers lined up outside the gates -- they would be lucky to have a job at your factory," said Harney, who spent two years interviewing workers, factory bosses and foreign investors in the region.

"Now a lot of factories I know are having to pay bonuses to workers to convince their family members to come and work there. They send them to the countryside and ask them to bring people back," she told AFP. "

alcan said...

I am confused so I will probably have to google "inflation expectations" unless you promise to help. Your post seems to portend rising inflation, however, if I am correct, you are long SMN. Wouldn't this be contradictory? Unless your SMN position is just a short-term trade.

npichick said...

I am in the belief that the Fed is "done" balancing the growth part and now is in the first few steps on cutting out the others. Chasing inflation with rate cut like Volcker is not what Ben is thinking I can logically hope.

Also particular to SMN, check out GSI. Block out the move on Friday and pretend you are there to forecast prices. Then read the news on GSI and you will see that when your input is yet another basic material you are looking to build an inverted pyramid, which is also part of the decoupling theory.

MTGSPY said...

Yes, I have seen GSI, which is eating inflation as cost like AA and DD. There is mindless grupies buying waiting for buyout rumors ro materialize, but i really think that's a pisspoor reason to buy.

MTGSPY said...

Alcan, one of the point I wanna drive is dont look for inflation in the CURRENT price of treasury. And the Fed knows it VERY WELL.

Douche_Bag said...

MTG. do you look for inflation in commod future prices ie backwardation vs contango
What indicators do you think the FED uses for inflation and can you give me a bit of insight into what you use??

Thanks man...

MTGSPY said...

The Fed does not look at SPOT inflation.

They look at the expectation of inflation, which sets the actual traded price in the market at this moment.

Right now that expectation is running lose. Please see the chart. The point it went lose was aproximately at BSC bailout. Now with financials raising capital somewhat, the Fed cannot but see their tasks remain elsewhere.

At this point, if they don't douse this fire right now they are NOT going to be able to douse it.

alcan said...

Are you hinting at increased jaw boning or an immediate reversal in interest rate policy? June 25th? I guess they could as the recession that never occured "ist endet".

douche_bag said...

it would be pretty sweet if the fed did an emergancy hike


yeah right

also mtg...have you any more insight into WB???

MTGSPY said...

Still havent shorted WB. Risk rewards look stunning in FED right now and always trying to find shares. WB earnings is 7/18 and plenty of time to wait, it may hit $30 while downside pressure will come as a) spring selling season winds down and b) earnings season shows up.

MTGSPY said...

Why would you say a hike is out of the question, especially a surprise hike? Aug Fed rate is showing trace probability of 2.25%.