argument is gaining…
The second is that key commodity prices and indexes are deflating. The CRB has made a lower low this week, driven lower by copper prices, which are leading the industrial metals complex, lower, as noted last week, and energy prices, which seem to be reacting to the same set of implications on demand. The crude oil chart (intermediate) is beginning to reveal a bearish bias, and could break down.
The third reason that the deflation argument has been gaining ground is that the trade deficit has been "gradually" narrowing on declining import demand, priced in US dollars.
However, and as a matter of fact, there is a significant difference between actually having an involuntary induced monetary deflation and observing specific deflationary forces, especially if the deflationary forces are deliberated by dollar policy.
Anything, which is deliberated is usually done so with an agenda but cannot be sustainable without new deliberations. At any rate, we have noted in the past that any decline in commodity prices that has resulted from the near 20% rise in the dollar since January is not a demand led decline. It's a price adjustment, motivated by the transfer of purchasing power from foreign trading partners to the US dollar. While the bearish developments in oil prices do surprise us, there is no sign of a slowdown in global consumption. Oil and gas inventories are not piling up because no one wants them.
On the contrary, rising inventories are a sign of continuing accumulation if anything. Yet, markets have been seeing this buildup as a future supply glut… another coup of dollar policy.
But here is the irony - the same currency policy was, and still is, responsible for the relative shortage of onshore natural resource capacity, as well as for accelerating inflation rates in Europe. And it is deliberated… to various economic and political ends.
Nonetheless, such a price adjustment in commodity prices is only temporary if it doesn't generate real growth, which it cannot, and if it continues to do away with the incentive for further investment in exploration and domestic production capacity.
The weakening manufacturing activity does not surprise us, but the reaction by the markets does. Rather than seeing it as the inevitable tension of an abusive dollar policy, markets have taken to a different signal today. They see it as impetus to a capital spending led boom in the technology and financial services sector. Bulls continue to view the manufacturing sector as the old economy, which is no surprise, but seeing them actually buy the line is.
Bullish on Basel II and Conceptual Content of GDP
"… pro-cyclical pattern of easing and tightening of bank lending and accordingly increase bank shareholder values and economic stability." Alan Greenspan, June 20
In the second speech, he credited the growth in post WWII productivity for the out-sized increase in conceptual GDP, relative to physical materials, and thus encouraged the labor department to focus on the educational standards, which have helped create this "conceptual GDP."
Right there is what drove the stock market activity today… Greenspan is still bullish on banks and productivity, which is why the banks and technology stocks were the recipients of new buying interest. Talk of lower interest rates now that deflation expectations appear to be rising, temporarily at least, have ignited the new economy theme on Wall Street this morning.
Debate and the Strategy
However, now that some of the inflation expectations in the U.S. have been culled, and the deflation debate has gained some footing, it is possible that the Treasury is prepared to allow the dollar to decline against the euro. If the FOMC lowers rates by 50 basis points next week, thereby allowing the euro to appreciate, the pressure for higher global interest rates may recede, for the moment. To some extent, we can't help but wonder whether the Europeans are using the GE/HON deal as extortion against the strong dollar?
Meanwhile, Goldman Sachs can begin to criticize the Japanese economy (it has) for not buying enough goods, and set up the dollar toggle - from the euro to yen, and back. Dollar policymakers need the dollar to decline against the euro, but they need to keep it firm against the other currencies, else risk dollar inflation. Will the Japanese support a strong dollar in order to re-inflate their economy? Not if they are trying to get the Asian region off of the dollar standard and persuade them to support a regional currency board, or unit.
These ad-hoc strategies, creative as they are, provide zero solution to the problem, but rather an international infrastructure, which allows the problem to remain hidden, if only increasingly temporarily. The problem is too many dollars. A 50 basis point rate cut will crush the bond market and dollar. There is no way the new economy will get a lift off of that. But gold prices will.
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