I want to extend my warmest thanks to those of you who joined me,
Chris Rowe, Ed Pawelec and Costas Bocelli this past weekend in
Delray Beach, Florida as we celebrated Chris’ retirement.
Activities ranged from the humorous -- such as the "impersonate Teeka Tiwari doing Morning GPS” contest -- to more serious business, such as how the rest of this trading year looks to pan out, along with classes that delved deep into options strategies.
It was a wonderful weekend, and it was a real treat for me to get to meet so many of our students and subscribers in person.
One of the key emerging themes we examined this weekend was confronting the specter of deflation.
Let me give a little background for those of you who may be unfamiliar with this term...
The simplest way to think of deflation is as the opposite of inflation. When we have inflation, prices go up; when we experience deflation, prices go down.
Lower prices seem like a really good deal... so, why should we be worried if the price of the stuff that we buy declines?
When goods and services have a sustained period of going down in price, buyers of those goods and services postpone their purchases, because they know that if they are a little patient they will be able to buy their goods and services for less.
What happens in a deflationary environment is that the buying power of paper money increases. So you actually make money by holding paper currency, because as deflation increases, the buying power of the dollars you hold in your pocket today increases over time.
This causes consumers and business to hoard cash and wait as long as possible before spending their money. Now, imagine the effect it would have on demand if the entire nation of consumers and businesses all decided to hold off on their purchases. It would lead to a grinding slowdown in economic growth, rather than a dramatic drop in demand. We know this for a fact, because history is full of examples of what happens when deflation hits.
The crippling slowdown in economic activity that led to the Great Depression, and the economic circumstances that led to the rise of Hitler were both examples of deflation at work.
If deflation were a good thing, then Japan would be in much better shape than it is in right now, because Japan has been experiencing deflation for more than 20 years.
During that period of time, Japan’s stock market has dropped more than 80%, real estate prices are still below their 1988 peaks, and the country has experienced multiple recessions.
They have also seen their 10-year bond yields drop to as low as 44 basis points! Current yields are now at around 1%, but why would anybody buy bonds that are yielding only 1%, not to mention as low as 0.44%?
In a deflationary environment, cash is king, and becomes a legitimate investment option. Because of the effect of inflation, cash is typically a poor investment, since the power of inflation constantly erodes its value. In other words, cash is typically a depreciating asset.
However, in a deflationary environment, cash becomes an appreciating asset. You actually get paid to hold cash. Your payment comes in the form of increased buying power of your cash. For example, in a deflationary environment $1 will buy $1 worth of goods this year, but it could (for example) buy $1.05 worth of goods next year.
That is an implied return of 5% on your money. Can you see now why so many Japanese citizens are keeping so much of their money in actual cash, and in Japanese government bonds that only pay between 44 basis points and one percent?
If deflation is coming to the United States, the two best performing assets will be government bonds and good old American green backs, AKA the US Dollar.
I can already hear you howling in protest at how ludicrous an assertion that it is.
US Treasury 10 Year Notes now yield approximately 1.86%. A little over a year ago they were at 4%! As such, you cannot deny that that the bond market continues to defy so called “logic” with its relentless move higher in price and lower in yield.
I also think it would be a mistake to dismiss the recent uptrend in the US Dollar. With or without deflation, both the dollar and the Treasury market look like they will continue to rally off the near certainty that the Europeans will be forced to both cut rates and flood the world with newly printed Euros.
Both of these events are bullish for the dollar and for Treasuries. So I urge you to keep an open mind and always remember that the financial market prides itself on making the greatest number of people wrong.
Activities ranged from the humorous -- such as the "impersonate Teeka Tiwari doing Morning GPS” contest -- to more serious business, such as how the rest of this trading year looks to pan out, along with classes that delved deep into options strategies.
It was a wonderful weekend, and it was a real treat for me to get to meet so many of our students and subscribers in person.
One of the key emerging themes we examined this weekend was confronting the specter of deflation.
Let me give a little background for those of you who may be unfamiliar with this term...
The simplest way to think of deflation is as the opposite of inflation. When we have inflation, prices go up; when we experience deflation, prices go down.
Lower prices seem like a really good deal... so, why should we be worried if the price of the stuff that we buy declines?
When goods and services have a sustained period of going down in price, buyers of those goods and services postpone their purchases, because they know that if they are a little patient they will be able to buy their goods and services for less.
What happens in a deflationary environment is that the buying power of paper money increases. So you actually make money by holding paper currency, because as deflation increases, the buying power of the dollars you hold in your pocket today increases over time.
This causes consumers and business to hoard cash and wait as long as possible before spending their money. Now, imagine the effect it would have on demand if the entire nation of consumers and businesses all decided to hold off on their purchases. It would lead to a grinding slowdown in economic growth, rather than a dramatic drop in demand. We know this for a fact, because history is full of examples of what happens when deflation hits.
The crippling slowdown in economic activity that led to the Great Depression, and the economic circumstances that led to the rise of Hitler were both examples of deflation at work.
If deflation were a good thing, then Japan would be in much better shape than it is in right now, because Japan has been experiencing deflation for more than 20 years.
During that period of time, Japan’s stock market has dropped more than 80%, real estate prices are still below their 1988 peaks, and the country has experienced multiple recessions.
They have also seen their 10-year bond yields drop to as low as 44 basis points! Current yields are now at around 1%, but why would anybody buy bonds that are yielding only 1%, not to mention as low as 0.44%?
In a deflationary environment, cash is king, and becomes a legitimate investment option. Because of the effect of inflation, cash is typically a poor investment, since the power of inflation constantly erodes its value. In other words, cash is typically a depreciating asset.
However, in a deflationary environment, cash becomes an appreciating asset. You actually get paid to hold cash. Your payment comes in the form of increased buying power of your cash. For example, in a deflationary environment $1 will buy $1 worth of goods this year, but it could (for example) buy $1.05 worth of goods next year.
That is an implied return of 5% on your money. Can you see now why so many Japanese citizens are keeping so much of their money in actual cash, and in Japanese government bonds that only pay between 44 basis points and one percent?
If deflation is coming to the United States, the two best performing assets will be government bonds and good old American green backs, AKA the US Dollar.
I can already hear you howling in protest at how ludicrous an assertion that it is.
US Treasury 10 Year Notes now yield approximately 1.86%. A little over a year ago they were at 4%! As such, you cannot deny that that the bond market continues to defy so called “logic” with its relentless move higher in price and lower in yield.
I also think it would be a mistake to dismiss the recent uptrend in the US Dollar. With or without deflation, both the dollar and the Treasury market look like they will continue to rally off the near certainty that the Europeans will be forced to both cut rates and flood the world with newly printed Euros.
Both of these events are bullish for the dollar and for Treasuries. So I urge you to keep an open mind and always remember that the financial market prides itself on making the greatest number of people wrong.
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