Author Topic: Deflation hedges  (Read 135522 times)

One World Trader

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Re: Deflation hedges
« Reply #20 on: January 14, 2015, 08:54:54 PM »
I understand, though hardly agree. Its exactly what they want you to think!!! As long as we're talking about spending while Americans are in debt, we are talking good short term gains for manufacturers and stores but bad long term games for the whole economy. Let me explain:

When individuals borrow and spend to finance productivity it is beneficial for the economy. In the past, individuals borrowed to build a factory which would produce goods that were sold at a profit that would pay off the loan. Today money is spent and borrowed for consumption whereas indebtedness grows while production capacity doesn't! For example buying a dress or football game tickets. The debt doesn't go away because there are no profits to pay off the debt from the spending.

I can think of an example country that is borrowing to build factories and their economy is growing rapidly... :)


petec

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Re: Deflation hedges
« Reply #21 on: January 15, 2015, 02:23:49 AM »

I can think of an example country that is borrowing to build factories and their economy is growing rapidly... :)

You can. but you might not want to.   The part you don't mention is that when people borrow to consume, someone somewhere borrows to build the plants to make the things that the consumers are consuming.   You might call this the "levering phase" and it works very well until the consumers, encumbered with debt, slow down their consumption.   Then neither group has the cash flows to pay off the loans.   Consumers consume less and start paying down loans.   Producers keep producing more and more to try to service their loans, but in the absence of demand they have to cut prices, and you get deflation.   You might call this the "delevering phase".   

If they're badly run the consuming countries will lower interest rates more and more and more to try to "stimulate demand", aka get levered consumers (or if that fails, governments) to lever more and spend more on more stuff that (mostly) doesn't produce an income.   If they're badly run the producing countries will borrow more and more to build more and more to keep headline GDP growing.   That's what China has spent the last few years doing.   Both policies just make the situation worse: more debt, more overcapacity, but no more demand.   It's extraordinary to think that global debt/GDP has gone from 175% in 2007 to 215% now.   The globe as a whole is not delevering, but the levering might be in its final phase.

I realise I'm drifting off topic here!

What is really interesting is whether Americans will spend their oil windfall, or use it to delever.   
« Last Edit: January 15, 2015, 04:08:31 AM by petec »
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ni-co

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Re: Deflation hedges
« Reply #22 on: January 15, 2015, 03:13:22 AM »

I can think of an example country that is borrowing to build factories and their economy is growing rapidly... :)

You can. but you might not want to.   The part you don't mention is that when people borrow to consume, someone somewhere borrows to build the plants to make the things that the consumers are consuming.   You might call this the "levering phase" and it works very well until the consumers, encumbered with debt, slow down their consumption.   Then neither group has the cash flows to pay off the loans.   Consumers consumer less and start paying down loans.   Producers keep producing more and more to try to service their loans, but in the absence of demand they have to cut prices, and you get deflation.   You might call this the "delevering phase".   

If they're badly run the consuming countries will lower interest rates more and more and more to try to "stimulate demand", aka get levered consumers (or if that fails, governments) to lever more and spend more on more stuff that (mostly) doesn't produce an income.   If they're badly run the producing countries will borrow more and more to build more and more to keep headline GDP growing.   That's what China has spent the last few years doing.   Both policies just make the situation worse: more debt, more overcapacity, but no more demand.   It's extraordinary to think that global GDP has gone from 175% in 2007 to 215% now.   The globe as a whole is not delevering, but the levering might be in its final phase.

I realise I'm drifting off topic here!

What is really interesting is whether Americans will spend their oil windfall, or use it to delever.

+1
This the right framework and exactly the right question.
« Last Edit: January 15, 2015, 03:17:34 AM by ni-co »

One World Trader

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Re: Deflation hedges
« Reply #23 on: January 15, 2015, 08:31:27 AM »

I can think of an example country that is borrowing to build factories and their economy is growing rapidly... :)

You can. but you might not want to.


Actually, I do, however not in the short term!

At the end of the day, which country has the factories to produce more goods and which ones have the consumer debt? Which one has the ability to make more profit? :)

 I agree with much of your response.  End of leveraging phase...absolutely. I agree that saying the economy grows in the long term with all this borrowing is unrealistic because sooner or later the buck has to stop because many less in America will have it to spend!

In addition, the US owes around 5 trillion to China. That would be easily deleveraged and the problems you speak of be fixed by selling off fixed assets in the USA to China. That shrinks the economy. This doesn't solve the problems within their governing system. It does however, mean that our economy would shrink accordingly to pay off the 5 trillion it owes while it deleverages.

Great final word, an important question!
« Last Edit: January 15, 2015, 08:34:28 AM by One World Trader »

KinAlberta

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Re: Deflation hedges
« Reply #24 on: January 19, 2015, 02:28:18 PM »
lower commodity prices means you can make stuff cheaper.
productivity gains mean you can make stuff cheaper.

lower commodity prices mean consumers can buy more stuff with same paycheck, leading to higher factory utilization and employment gains,

higher productivity means we make products with fewer people.

lately I believe productivity has disappointed during an environment of cheaper commodities.  Isn't this a bullish combination for capacity utilization and employment gains? Somehow I believe that is a headwind to deflation.

What was first, deflation or lower oil prices?

Well in Japan they had deflation even with rising commodity prices.

We're not seeing deflation here yet, but we are seeing lower commodities.  Real purchasing power is rising as is employment.  So far anyway   :-X

I have been thinking about it a lot lately and I'm still not sure about it. Why did we have high(er) oil prices in the face of the whole shale gas revolution only a few months ago? To me, it seems more probable that the prices are reacting to deflationary pressures from all around the world (but the US). I'm really curious whether we will see this working out as economic stimulus for the US economy or more as importing deflation.

Gundlach talked about this lately: http://video.cnbc.com/gallery/?video=3000333313
He is using oil as a leading indicator for the CPI.

I recall going to a dinner arranged on this board before the 2009 annual dinner and someone asked Sam Mitchell: inflation or deflation?   He said: both, and what really matters is when one turns into the other.

I'm inclined to think he's right, and I think commodity prices coming down are deflationary at first, and that is so good for the economy that Eric's thesis plays out and we get wage growth and a little inflation.

But the third order effect is that, with those elements of the economy normalised, CBanks can and might have to raise rates, and it is quite possible that that will cause havoc.

Now, by the time you get to third order events your chance of making a correct prediction is so small as to make the exercise pointless!   But I can see how Prem's 2011 forecast of a possible decade of flattish nominal GDP with bouts of deflation might come true.

But then I suppose any forecast *might* come true ;)

I know back in 2010 or so, everyone was expecting a lot of inflation to appear by right about now.  So, since those expectations have changed quite dramatically or at a minimum those expectations have been pushed back by a few years, I would think that their hedges should be doing alright.  Am I way off base here?

JEast

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Re: Deflation hedges
« Reply #25 on: January 23, 2015, 08:27:19 AM »
FYI on 5Y5Y expectations. Hopefully we at least get our capital back in 2015 and maybe a little extra in 2016.


JEast

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Re: Deflation hedges
« Reply #26 on: January 29, 2015, 06:05:17 AM »
It is still early, but I am hopeful that the Toronto office is now at least getting some calls on possible asking prices.


james22

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Re: Deflation hedges
« Reply #27 on: January 29, 2015, 11:19:32 PM »
All this talk of deflate-gate got me thinking about another kind of deflation.  No, Prem Watsa (Chairman and CEO of Fairfax Financial Holdings (FRFHF)) doesn't have a put option on air pressures of footballs, but he does have a massive bet on global deflation.  It's scary how big the bet has become.

http://brooklyninvestor.blogspot.com/2015/01/watsas-massive-bet.html#comment-form
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JEast

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Re: Deflation hedges
« Reply #28 on: January 30, 2015, 05:51:17 AM »
Big bet -- yes and no.  The amounts quoted are 'notional' amounts just like the previous credit default swaps.  The invested amount is but a fraction of the notional amounts reported which is roughly about $640m and worth about $110m at 3rd quarter.  A big bet, yes, but also no, wrt notional amounts.

I am hopeful that we at least get our money back with a possible option call on something more.  As an FYI, looks like 30-year Bunds are now below 1% (repeat, 30-year government debt).  Also, the Eurozone is starting to turn over as indicated below.



giofranchi

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Re: Deflation hedges
« Reply #29 on: January 30, 2015, 06:29:53 AM »
JEast,
The Brooklyn Investor ends its post saying:
Quote
This can be the trade of the century if we dip into deflation; the ultimate limited risk (don't lose much if wrong)/ high return (huge gains if right) trade.
Therefore, it seems the two of you are on the same page! ;)

Cheers,

Gio
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