Jay Taylor’s Inflation/Deflation Watch (IDW)

This week my IDW made another new high since its January 31, 2005, inception. For various reasons I have discussed of late, I fear that we are entering a period of time in which hyperinflation occurs, not in terms of financial assets so much as in normal cost-of-living items. To a greater or lesser extent, I expect the upward propulsion of my IDW will be tempered by a huge amount of money coming out of bonds and then stocks, as high-powered money at the Fed is flushed out from the grasp of bankers because, as interest rates continue to rise, they will find themselves losing money on their Treasury positions. That will force them to sell Treasuries and use the proceeds to make loans, thus pushing a massive multiple of those trillions of dollars sitting at the Fed into the real economy. With interest rates rising, that should put pressure on the stock market, but so far that does not seem to be happening. No doubt the thinking on the part of most people who rely totally on happy talk from Wall Street stock pimps is that rising rates are taking place because the economy is so strong and that finally, after eight or nine years following the financial crisis, everything is well in the world again.

Of course, we know nothing could be further from the truth. Financial asset price explosion has taken place because of artificial stimulus in the form of trillions of dollars created out of thin air and deposited in the form of high-powered money stored at the Fed, as the picture of the Fed’s monetary base above shows. The problem with artificial money like the fiat dollar is that there is no asset behind it, as was true under the gold-backed dollar. Well, that’s not quite true; there is something behind the dollar and that is debt—massive amounts of it, which is why it is only a matter of time before the existing system is set to collapse once again. No wonder China and Russia are setting up institutions and a monetary system backed by gold to compete and ultimately threaten the U.S. dollar.

I have long been more of a deflationist than an inflationist and as long as the dollar remained the dominant reserve currency I think that was a legitimate position to take. However, as I expect Chris Martinson will explain on my radio show next week, the dollar’s days are likely numbered. If the dollar loses a major portion of its value, vis-à-vis other currencies, then everything imported into the U.S. will become a lot more expensive.

Let me share my thoughts about the dynamics that might set the dollar’s decline into motion. First of all, we can no longer rely on “the kindness of strangers” (like Russia and China) to provide savings to offset America’s excessive spending. In fact, they are doing all they can to eliminate their ownership of dollars, which is the main reason I believe the threat of World War III is rising dramatically. (Read here how Putin is telling companies to get ready to supply needs for war, https://www.rt.com/politics/410646-putin-orders-all-russian-companies/.)

So if net saving nations stop buying Treasuries, the Fed will have to continue printing them to pay for our $20-trillion debt load, which is growing dramatically under Trump. Printing hundreds of billions of more dollars rather than using those dollars already earned and held by foreign savers will put downward pressure on the value of the dollar, vis-à-vis other currencies. Indeed, I believe the lack of willing foreign buyers of Treasuries is the real reason rates are now rising, not because the economy is doing so well.

As the dollar continues to decline and the CPI begins to rise, the Fed will be under pressure to hold back the money supply in order to let rates rise so it can attract buyers of Treasuries rather than printing endless amounts of money. But given the addiction to cheap money for so many years, not only state, local, and federal governments are over their heads in debt but so also are corporations who have collectively borrowed trillions of dollars not to build plant and equipment but to boost stock prices for their own enrichment. As a result, any significant rise in interest rates will not only chock off economic growth but given the enormous amount of debt service required by government and the private sector, trigger another financial crisis far greater than that of 2008-09. The next crisis will be greater because, nothing from the last crisis has been fixed and the global economy is far more leveraged now than in 2008. As James Rickards has said on my radio show, in the last crisis the banks were bailed out by the Fed. Now the Fed has too much debt for another bail out. The only entity that has a strong enough balance sheet to bail out the banks is the IMF. And, that is another reason I think the dollars days are numbered.

Thus the Fed will find itself between a rock and a hard place. It will be forced to raise rates just to attract buyers of Treasuries, but it won’t be able to raise them like Volcker did in 1979, because with the enormous amount of debt to GDP now in place, rates even half as high as the 17% I paid on my first mortgage in 1980 will send the U.S. economy into a tailspin that will likely make the 2008-09 episode look like child’s play. The fraudsters who have run our country since 1971 when Nixon took us off the gold standard have had quite an orgy setting off asset prices into the stratosphere and redistributing wealth away from those who produce it—the miners, manufacturers, farmers, and inventors—to the bankers and politicians. A day of reckoning is upon us. Now more than ever, simple logic calls for rational investors to allocate at least some of their assets into an asset-backed money like gold and/or silver.

This week I posted an article at www.Miningstocks.com titled “The Yield Curve, Something Much Worse Is Around the Corner.” It was written by Bill Blain of Mint Partners. I’m passing it on to you because this article suggests that the real danger lying ahead of is inflation. As such, I see it agreeing with what my IDW is saying, namely, that inflation is in the process of a major breakout though very few people can see it coming. I think my IDW is warning us of that and apparently so does Mr. Blain.

Stop worrying about the US yield curve – it’s a distortion. Something much worse is around the corner….

A bit of a feeding frenzy in the new issue primary bond market as 21 deals hit the screen and went fairly well. With Thanksgiving tomorrow it’s likely the tail of the week will be very quiet, but our primary trading team reckon there is still plenty of momentum. We’re likely to see another two weeks of proper activity before the holiday slowdown. There are a large number of deals queued up and still to come to market.

I wonder if the Credit Markets will be as busy next year?

It rather depends. Regular readers will know I’m uber-bearish and expecting the big bond market crash coming sometime soon, but others point to the US yield curve as evidence of a slowdown and therefore favourable conditions for the bond binge to continue – what’s not to like for issuers looking for almost zero cost money?

Frankly, there is far too much guff and nonsense about the US yield curve… so, it’s time for me to scare you some more, and add some Blain mumbo-jumbo to the mix.

It’s pretty simple.

The flatter US curve is NOT sending a deep meaningful warning of looming recession. It’s hiding something much worse….

The short-end of the US curve reflects what the Fed has done in terms of hiking rates. But, the long end of the US Curve (10-30) is being driven by very different forces. It has flattened because of interest rate differentials between the ZIRP rest of world and the rate normalising US, but also on the fact external investors effectively drive US rates because they are the forced buyers! Ongoing QE distortions in Europe and Japan are still driving close to Zero domestic interest rates – forcing investors offshore. Global demand for duration partially explains why the US 10-30 curve appears to have flattened.

The transmission effects of $5 trillion QE in last three years is a massive allocation towards US assets – which explains why the 10-yr is sticking round 2.5% and the term perimum is negative. Remove these effects of global distortion and the US curve would look much steeper and cause far less fear, panic and mania than the yield curve doomsters perceive.


The yield curve is not the thing to worry about..

I did read another yield curve view on Bloomberg: “The yield curve is inexorably flattening because duration is the hedge, not the risk, when it’s paired with a long equity component.”

Anticipating the imminent stock market meltdown with long duration bonds kind of makes some sort of sense – but I’m convinced that is going to be a massively expensive strategy.

Why? Because something much more wicked this way comes…..

That dark thing is inflation!

Over the last 10-years – since the Global Financial Crisis – we’ve seen the main drivers of inflation stagnate across the board. (I’ve argued many times if you want to see inflation then look at financial assets.) While prices and inflation signals have flat-lined, the inflation Central Bank feared they would create through QE has been incubating in massively inflated real assets – stocks and bonds.

My Macro Economist colleague Martin Malone reckons an inflation shock is now a 50% plus risk! He points out all the major inflation drivers are coming back on line.  

  • Global inflationary expectations have risen dramatically this year
  • Inflation data – which was deflationary 5 years ago, then flat, has now accelerated towards more normal levels
  • The safe asset long-term rate – in effect government bonds – are beginning to normalise
  • Output gaps are increasing and positive around the globe
  • Real Asset Prices – particularly housing and real estate rose dramatically over last 3 years
  • Risk Assets – like bond and stocks remain hugely inflated
  • Oil and commodities prices are rising
  • Jobs are being created around the world, and increasing number of countries now looking at supply side fiscal policy means wage inflation looks inevitable! The Philips Curve returns!  

Malone has quantified all the inflation drivers and added them up. He reckons in inflation drivers haven’t been this high since 2007! (If you want the numbers – let me know!)

Ask anyone on the street about inflation and they’ll tell you it’s very real. Wages have stagnated for 10-years, but prices are clearly rising. And look at UK housing – up 50% over 5-years!

One further driver of inflation may be China. (Yep, I know – it’s too easy.. If in doubt about markets, blame China.) For years I’ve been arguing the real risk in China isn’t creating enough jobs to keep the populace happy – it’s actually been about a revolution caused by the increasingly perilous state of the Chinese environment.

The leadership has now made the environment the number 1 priority – they get it and are acting accordingly. Pollution is the enemy. It’s not just coal fired power stations, but agriculture is a major source of river pollution – especially from Pigs. So piggeries have been “emptied” and hog prices are through the roof. As these supply side policies hit prices, the government is forced to raise wages. Wage inflation driven by rising food prices.

 Go figure what happens elsewhere as China drives up protein and carbohydrate prices. – Bill Blain

Your Editor’s Remarks: The inflationary scenario for 2018 fits Michael Oliver’s assessment of various markets, especially soft commodities, which he adamantly claims will explode higher in 2018. Talk about political pressure on Trump. If food prices start to rise dramatically in the U.S., he hasn’t seen anything yet!

Alasdair Macleod, a frequent guest on my radio show, wrote an excellent article titled “We Must Embrace Deflation.” Alasdair is right, of course, because when the market is allowed to work, prices not only go up but down and in the process real economic growth explodes higher because the market is allowed to do its work in efficiently allocating resources. Go to the Miningstocks home page here, www.Miningstocks.com, for the link to Alasdair’s article. Unfortunately, politicians and bankers are interested in short-term gains so they are not likely to embrace deflation. So the odds of rising prices are very, very high.

About Jay Taylor

Jay Taylor is editor of J Taylor's Gold, Energy & Tech Stocks newsletter. His interest in the role gold has played in U.S. monetary history led him to research gold and into analyzing and investing in junior gold shares. Currently he also hosts his own one-hour weekly radio show Turning Hard Times Into Good Times,” which features high profile guests who discuss leading economic issues of our day. The show also discusses investment opportunities primarily in the precious metals mining sector. He has been a guest on CNBC, Fox, Bloomberg and BNN and many mining conferences.