WEBVTT NOTE Coping in a Bear Market 1 00:00:00.000 --> 00:00:20.000 Generalised, rather than particularised over production, is a harmful nonsense, and secondly, since we have no access to the staff with which Moses struck the rock, nor a ready supply of manner for the asking, we must realise that production is what creates wealth and consumption, conversely, is what extinguishes it. 2 00:00:20.000 --> 00:00:25.040 Thus, contrary to Keynesian and monetarist thinking, stimulating spending of itself says 3 00:00:25.040 --> 00:00:29.360 little about whether this would be a force for good or ill, though it may very well manage 4 00:00:29.360 --> 00:00:35.200 to induce an increase in the aggregative statistical artefact, which is GDP. 5 00:00:35.200 --> 00:00:40.360 What spending does is not to create wealth, but to direct the form of its realisation. 6 00:00:40.360 --> 00:00:45.160 Consumption is a vote, not a magic action to distance which generates output automatically, 7 00:00:45.160 --> 00:00:47.440 much less investment. 8 00:00:47.440 --> 00:00:51.800 Depending via its generation of price signals tells entrepreneurs what is the overall ordering 9 00:00:51.800 --> 00:00:55.840 of preference for goods and services and gives them the starting point upon which they must 10 00:00:55.840 --> 00:01:00.080 base their own estimates of the price they can afford to pay for inputs of land, labour 11 00:01:00.080 --> 00:01:04.000 and other factors of production necessary for them to contribute towards the delivery 12 00:01:04.000 --> 00:01:07.520 of the goods and services most urgently wanted. 13 00:01:07.520 --> 00:01:11.640 Once they come to expect they can achieve this with a surplus, a profit in other words, 14 00:01:11.640 --> 00:01:15.480 they will compete for those means they judge necessary and in that competition will further 15 00:01:15.480 --> 00:01:22.480 will further influence an array of prices of all raw materials, business services, rentals, intermediate, capital goods in the market, 16 00:01:22.480 --> 00:01:28.480 and will thus be continuously engaged in calculating and recalculating input to expected output margins. 17 00:01:28.480 --> 00:01:33.480 A good part of these costs are associated with carrying the enterprise through time to its fruition. 18 00:01:33.480 --> 00:01:38.480 Goods do not appear instantaneously upon the shelf, no matter how insistent the desire for them, 19 00:01:38.480 --> 00:01:42.480 nor how wonderful the technology of Mr Greenspan's blessed inventory management. 20 00:01:42.480 --> 00:01:48.480 Here the interest rate as the crucial, if derivative, determinant of the cost of capital on the market plays its role. 21 00:01:48.480 --> 00:01:54.480 In a market where the supply of money was fixed, or at least changed so slowly as to make no practical difference, 22 00:01:54.480 --> 00:01:58.480 the interest rate would most closely reflect people's time preferences, 23 00:01:58.480 --> 00:02:03.480 that is, their degree of impatience in wanting goods today rather than tomorrow. 24 00:02:03.480 --> 00:02:10.480 Now this sets us up for what, in distinction to the fallacious Keynesian paradox of thrift, is in fact a paradox of consumption. 25 00:02:10.480 --> 00:02:16.480 The more aggressive our demands for current goods, the less surplus we leave over from everyone's current round of labours, 26 00:02:16.480 --> 00:02:18.480 or put another way, the less savings we make. 27 00:02:18.480 --> 00:02:23.480 Thus, the less of the pool of real capital, and in this case its corresponding monetary form, 28 00:02:23.480 --> 00:02:27.480 which can be made available to help produce the goods we want to consume in the future. 29 00:02:27.480 --> 00:02:31.480 From this extra current pressure comes a higher natural rate of interest 30 00:02:31.480 --> 00:02:35.480 and so a clear signal to entrepreneurs, through this most vital of prices, 31 00:02:35.480 --> 00:02:40.040 that means a scarce and so long duration or thinly margined or more speculative 32 00:02:40.040 --> 00:02:42.480 undertakings are all too likely to fail. 33 00:02:42.480 --> 00:02:46.160 Thus the entrepreneurial efforts will be more narrowly based on more immediate 34 00:02:46.160 --> 00:02:47.040 production modes 35 00:02:47.040 --> 00:02:50.720 and in the extreme on simple bilateral exchange or even self-sufficiency. 36 00:02:50.720 --> 00:02:55.240 As the last suggests with its echoes of a primitive society 37 00:02:55.240 --> 00:02:59.120 this is not a route to increase prosperity. So the upshot is 38 00:02:59.120 --> 00:03:02.440 that rather than having a negative feedback leading to a cycle of decline 39 00:03:02.440 --> 00:03:04.160 based on too much saving 40 00:03:04.160 --> 00:03:34.160 We have one based on saving too little, but of course we don't live in that world, we live in one where Alan Greenspan is merely the most egregious and happily influential player in his belief that he can better set a rate of interest than can the interactions of a myriad of freely acting individuals by slowing or accelerating the swelling of the Fred's balance sheet around its 30-year secular trend. 41 00:03:34.160 --> 00:03:39.760 ran its 30-year secular trend of 6.8% a year growth, an arbitrary number. 42 00:03:39.760 --> 00:03:48.360 Thus the vital price signals are confused by the emphatic non-neutrality of money in its injection effects, i.e. who gets it first and what they do with it, 43 00:03:48.360 --> 00:03:53.560 and in the amplification of these by today's hyperactive financial architecture, 44 00:03:53.560 --> 00:03:58.360 which has a penchant for bringing unimaginable leverage to bear, as Jean was pointing out, 45 00:03:58.360 --> 00:04:04.360 on tradable qualities deemed by the herd to be too high or too low in price at any given instant. 46 00:04:04.360 --> 00:04:11.360 So relative prices get distorted and they may also be made damagingly volatile and erratic in nature by monetary manipulation. 47 00:04:11.360 --> 00:04:17.360 In this manner the rates are distorted by the impact of inflationary credit on financial market asset prices 48 00:04:17.360 --> 00:04:23.360 and these feed back very strongly in the John Law spiral of monetised collateral in which we live. 49 00:04:23.360 --> 00:04:27.800 Thus entrepreneurs become confused, people misdirect their labors, and we all keep on 50 00:04:27.800 --> 00:04:31.680 misallocating our real capital while piling out yet more credit. 51 00:04:31.680 --> 00:04:36.160 That explains the business cycle in its essence, but we've had two new twists in this recent 52 00:04:36.160 --> 00:04:40.880 one, which helps explain why it grew to an extent potentially more unbalanced than previously 53 00:04:40.880 --> 00:04:41.880 seen. 54 00:04:41.880 --> 00:04:45.080 The simple first factor is technological gee-wizzery. 55 00:04:45.080 --> 00:04:48.880 Like kids with noses against the toy shop window, we're always impressed by shiny new 56 00:04:48.880 --> 00:04:53.320 gadgetry and we lapsed into a syndrome where we steeped ourselves in the trading card mentality 57 00:04:53.320 --> 00:04:58.320 and judgment became suspended in favor of novelty and to some extent it still is. 58 00:04:58.320 --> 00:05:05.320 Cisco, Intel, Oracle, Microsoft and their ilk still dominate both financial news and daily trading volumes. 59 00:05:05.320 --> 00:05:08.320 The second more important factor is the external one. 60 00:05:08.320 --> 00:05:14.320 This could be looked upon as the western fruits of globalization or its dark side, dollar imperialism. 61 00:05:14.320 --> 00:05:21.320 Somewhere between the fall of the Berlin Wall and the tequila crisis of 95, a major external shift began. 62 00:05:21.320 --> 00:05:27.320 A major external shift began, and this accelerated after the events of the 97-98 Asian Contagion. 63 00:05:27.320 --> 00:05:37.320 Foreigners started to build up official reserves, a tendency which swelled to the tune of $400 billion worth of extra seniorage from 1997 to 2000. 64 00:05:37.320 --> 00:05:41.320 They also began to accumulate other forms of US debt in an inordinate manner. 65 00:05:41.320 --> 00:05:43.320 The figures are sobering. 66 00:05:43.320 --> 00:05:48.600 74% of all corporate bond inflows for the past 50 years have been concentrated in just 67 00:05:48.600 --> 00:05:55.360 the last 6, as has 79% of all foreign buying of agency paper. Foreigners have also been 68 00:05:55.360 --> 00:05:59.800 rather less than astute in buying 85% of all their US equities in these most overpriced 69 00:05:59.800 --> 00:06:04.920 of years, but in fact net equity flows were negative, and even if we add in direct investment, 70 00:06:04.920 --> 00:06:10.080 which was often financed with these equity stock swaps, this only contributes $230 billion 71 00:06:10.080 --> 00:06:17.080 to America's External Deficit, whereas bonds make up 1.9 trillion gross and 1.7 trillion net. 72 00:06:17.080 --> 00:06:23.080 In fact, 68% of all portfolio and foreign direct investment flows to the United States 73 00:06:23.080 --> 00:06:29.080 since the Korean War have been made since the bubble began and they are all essentially bond liabilities. 74 00:06:29.080 --> 00:06:39.900 This trend has been absolutely key to preventing America's Ponzi scheme inflationary finance 75 00:06:39.900 --> 00:06:44.200 and its yawning trade deficit from igniting the sort of price inflation which short circuits 76 00:06:44.200 --> 00:06:46.140 more typical business cycles. 77 00:06:46.140 --> 00:06:49.680 It is also clearly America's sword of Damocles. 78 00:06:49.680 --> 00:06:54.280 Private foreigners have built up balances in exchange for cheap goods and official foreigners 79 00:06:54.280 --> 00:06:58.360 have expanded their reserve bases and hence their money supply on the accumulation of 80 00:06:58.360 --> 00:07:13.360 This has helped appreciate their currencies, which while pushing up locally counted export earnings, has also represented an effective channel of taxation on their peoples via the inflation, and that tax has gone to subsidise what we call Atlantic consortium consumers. 81 00:07:13.360 --> 00:07:27.360 For so long as it lasted, with the aid of the odd monetary collapse in those nations along the way, this seemingly costless expansion of credit unfortunately served to tune everybody's production at once to Anglo-American consumers and to the high-tech fallacies of the Atlantic economy. 82 00:07:27.360 --> 00:07:29.360 fallacies of the Atlantic business model. 83 00:07:29.360 --> 00:07:35.360 Meanwhile, the homegrown credit bubble drove a huge wedge between savings and investment, 84 00:07:35.360 --> 00:07:40.800 to the point that, over the last three years for the first time on record, U.S. gross non-financial 85 00:07:40.800 --> 00:07:45.520 business investment has not been matched by a combination of household savings and businesses 86 00:07:45.520 --> 00:07:48.640 own internally generated funds. 87 00:07:48.640 --> 00:07:52.800 The reason this has not torn the system apart in a civil war of consumers and producers 88 00:07:52.800 --> 00:07:57.320 battling for goods is a good old Johnny Foreigner has been pleased to provide those goods on 89 00:07:57.320 --> 00:08:01.860 Even so, adding the fact that our wonderful corporates have been using much of what they 90 00:08:01.860 --> 00:08:07.160 have made in retiring arguably the most expensive equity in history, which is something their 91 00:08:07.160 --> 00:08:12.880 1920s predecessors were not dumb enough to do, and we have had a $1.1 trillion hole blown 92 00:08:12.880 --> 00:08:17.140 in the accounts since the long-term capital management crisis of 1998. 93 00:08:17.140 --> 00:08:21.580 But no matter, for an exponential growth in credit extension and financial leverage has 94 00:08:21.580 --> 00:08:23.480 helped fill this chasm. 95 00:08:23.480 --> 00:08:27.480 If we look at the growth of financial market debt over the last three years, we find an 96 00:08:27.480 --> 00:08:33.720 extra $1.20 has been conjured up for every $1 of combined private savings. 97 00:08:33.720 --> 00:08:38.240 For a sense of scale, we should compare this to the previous cycle's high of only $0.48 98 00:08:38.240 --> 00:08:43.320 to the dollar and the intervening $0.92 low of $0.28. 99 00:08:43.320 --> 00:08:48.200 At the same time, outstanding derivatives contracts, instruments used to cut, paste, 100 00:08:48.200 --> 00:08:52.760 bundle, gamble on moves in the underlying economic quantities, have burgeoned from $56 101 00:08:52.760 --> 00:09:22.240 A monetary expansion works essentially by changing prices upwards once more, though 102 00:09:22.240 --> 00:09:28.240 Now, this is much more haphazard and random than the homogeneous goods thinkers like standard monetarists and Keynesians believe. 103 00:09:28.240 --> 00:09:33.240 And so it's hardly guaranteed to be of any overall benefit once we jump through Bastiat's window. 104 00:09:33.240 --> 00:09:38.240 What is more certain, though, is that it can unlock that portion of productive capacity, 105 00:09:38.240 --> 00:09:44.240 which has been frozen up and prevented by the existing costs and refinancing apparatus of its debt load 106 00:09:44.240 --> 00:09:48.240 from not repricing its output to better suit the market. 107 00:09:48.240 --> 00:09:54.840 Now, unfortunately, this means that firms stubbornly attempting to sell goods at above-clearing prices with shaky balance sheets 108 00:09:54.840 --> 00:09:59.200 are being supported at the expense of the nimble, the well-managed and the innovative. 109 00:09:59.200 --> 00:10:02.540 Look at Compaq or IBM against Dell for an instance of this. 110 00:10:02.540 --> 00:10:07.140 Without the debt machine, the first two long ago would have surrendered the market wholly to the latter. 111 00:10:07.140 --> 00:10:10.740 Now, more soberingly, you should look at Japan or Korea or China, 112 00:10:10.740 --> 00:10:17.740 where karetsu and kaibol and state-owned enterprises rely upon vast infusions of dishonest money for survival to the detriment of all 113 00:10:17.740 --> 00:10:21.740 and look too at what dishonest money achieves through the equity channel in the West. 114 00:10:21.740 --> 00:10:27.740 It is certain that to the extent Greenspan has not simply stored up an even larger financial system crisis, 115 00:10:27.740 --> 00:10:32.740 a huge volume of easily mobilized liquidity is available for activation in spending. 116 00:10:32.740 --> 00:10:37.740 If the private sector stops the purposeless exercise of piling up more debt with the right hand 117 00:10:37.740 --> 00:11:04.740 Given we started this discussion by arguing that too much spending was further weakening an overly prolonged capital structure, there is a significant risk that this will mean increasingly insistent signs of price inflation, and this could possibly be by the late spring as a realignment is sought once more. 118 00:11:04.740 --> 00:11:16.740 This can take place even if unemployment rises, unless we shift to a retirement or immobilization of money through private thrift or through extinguishing it by default or deliberate central bank policy. 119 00:11:16.740 --> 00:11:25.740 A GDP may well rise in the absence of this and the hosannas will resound unto the heavens, even though the economy is becoming inherently weaker as spending grows. 120 00:11:25.740 --> 00:11:33.740 This is especially conceivable for the services component, which is around five times the dollar value of equipment and software investment spending. 121 00:11:33.740 --> 00:11:34.740 Spending. 122 00:11:34.740 --> 00:11:40.700 So this means a mere 2.1% rise in haircuts and hotel meals would mask a 10% fall in face 123 00:11:40.700 --> 00:11:44.980 recognition technology and human ID chips, which maybe isn't such a bad thing after 124 00:11:44.980 --> 00:11:45.980 all. 125 00:11:45.980 --> 00:11:49.500 But don't forget, government looms twice as large as capital investment in national 126 00:11:49.500 --> 00:11:50.940 accounts also. 127 00:11:50.940 --> 00:11:55.300 With Bush about to finance a six-year crusade as well as a host of unnecessary programmes, 128 00:11:55.300 --> 00:11:59.780 GDP may well go up, but LBJ, the last man to do likewise, didn't leave the world a 129 00:11:59.780 --> 00:12:03.480 better place than when he embarked upon the course. 130 00:12:03.480 --> 00:12:07.240 There will be plenty of government borrowers this year ready to squander proceeds of bank 131 00:12:07.240 --> 00:12:12.520 credit creation, even if the private sector becomes more reluctant to play, again an argument 132 00:12:12.520 --> 00:12:16.120 at this point against deflation. 133 00:12:16.120 --> 00:12:19.360 Initially the improvement in spending will be sold as a renewed golden age. 134 00:12:19.360 --> 00:12:22.720 The Wall Street herd will be out in force bad mouthing other currencies like the yen 135 00:12:22.720 --> 00:12:26.480 and the euro to forestall the dollar's day of reckoning, and this could take us easily 136 00:12:26.480 --> 00:12:28.640 into the second part of the year. 137 00:12:28.640 --> 00:12:32.960 But at this point the trade deficit will be widening, internal saving will be suppressed 138 00:12:32.960 --> 00:12:36.720 and interest rates will be biased higher if not overwhelmingly so 139 00:12:36.720 --> 00:12:39.860 in what would be a mild bear market for bonds. 140 00:12:39.860 --> 00:12:43.720 Investment spending too and thus the loop between this and significant corporate 141 00:12:43.720 --> 00:12:46.880 revenue and earning enhancement will be largely absent 142 00:12:46.880 --> 00:12:50.480 so equities may not wilt but neither are they likely to thrive according to the 143 00:12:50.480 --> 00:12:52.580 norms of recent years. 144 00:12:52.580 --> 00:12:55.940 Again in all this the only escape route from an eventual deterioration in the 145 00:12:55.940 --> 00:12:57.280 CPI index 146 00:12:57.280 --> 00:13:00.600 seems to be the continuation of the US dollar's attractiveness to less high 147 00:13:00.600 --> 00:13:02.320 rolling foreigners 148 00:13:02.320 --> 00:13:06.840 But with no new era, only sunset industry style growth likely, together with another 149 00:13:06.840 --> 00:13:11.440 widening of the trade gap and with portfolios already hugely overexposed, this too looks 150 00:13:11.440 --> 00:13:15.200 like a challenge, 6th fleet or no. 151 00:13:15.200 --> 00:13:18.720 Now if the Fed does not act to guard against these effects, bondholders will become increasingly 152 00:13:18.720 --> 00:13:20.480 uneasy about the impact. 153 00:13:20.480 --> 00:13:25.000 The yield curve will steepen bearishly as long bond rates rise fastest, and their foreign 154 00:13:25.000 --> 00:13:29.120 holders might compound both the markets woes and the inflationary impact through selling 155 00:13:29.120 --> 00:13:32.120 quantities of their now surplus dollars. 156 00:13:32.120 --> 00:13:36.800 But then if the Fed does act, or is credibly held to be on the verge of acting, the front 157 00:13:36.800 --> 00:13:40.680 end with its unprecedented speculative overhang left from all the interest rate reductions 158 00:13:40.680 --> 00:13:45.400 last year will buckle first and will suffer a sell-off led by shorter maturities, again 159 00:13:45.400 --> 00:13:50.040 this might hurt the dollar, and might require increasing degrees of Fed aggressiveness 160 00:13:50.040 --> 00:13:54.400 in an attempt to front load the pain and get ahead of the curve as they say. 161 00:13:54.400 --> 00:13:58.520 The first scenario may just be to equities benefit, especially those of providers of 162 00:13:58.520 --> 00:14:05.520 The second scenario though is likely to be much more malign. It would imply tighter, or at least less easy, liquidity, as well as higher bond yields, and a contraction of both earnings and multiples would then be in prospect. 163 00:14:28.520 --> 00:14:52.520 An outcome along the lines of the first is broadly conducive for diminishing risk premier on corporate bonds and other secondary instruments, the second, because of the quality considerations, would probably favor US Treasuries. 164 00:14:52.520 --> 00:15:03.520 If you ask us which way we think the dice will fall, as betting men we can't really say that Greenspan would do anything so politically contentious as tightening, early and causing problems. 165 00:15:03.520 --> 00:15:16.520 And now that he's lost the nagging conscience of Governor Mayer, one of the few intellectually rigorous board members, though unfortunately of course a rigorous Keynesian, he has little opposition to look forward to from the placemen and the Bush appointed tyrants on the committee. 166 00:15:16.520 --> 00:15:21.820 Now we should take a quick detour here and pay cursory attention to a wider world and 167 00:15:21.820 --> 00:15:26.600 pay a swift abasance to America's numerous and generous offshore creditors in order to 168 00:15:26.600 --> 00:15:29.760 estimate their effects on the US cycle. 169 00:15:29.760 --> 00:15:34.280 Europe has its problems, Telecom and Techmania did hit, as well as other foolish attempts 170 00:15:34.280 --> 00:15:38.000 to emulate the Yankees and the roast beef's worst corporate misadventures. 171 00:15:38.000 --> 00:15:43.280 Iberian banks failed attempts at a peso reconquista will hurt, but malinvestment has not been 172 00:15:43.280 --> 00:15:47.680 and so widespread, given that much of Europe's extra credit creation was used to buy Anglo-American 173 00:15:47.680 --> 00:15:49.680 securities and companies. 174 00:15:49.680 --> 00:15:55.120 Moreover, in most European countries, private saving easily covers investment, so a progressive 175 00:15:55.120 --> 00:15:59.400 impoverishment should not take place on the Anglo model unless governments abandon all 176 00:15:59.400 --> 00:16:04.400 pretence at adhering to their budgetary stability pact and the mantra of structural reform, 177 00:16:04.400 --> 00:16:06.760 however anemic. 178 00:16:06.760 --> 00:16:10.440 There also seems to be a firming resolve from the newly confident European Central Bank 179 00:16:10.440 --> 00:16:14.600 that the old Bundesbank credo of no counter-cyclical monetary policy 180 00:16:14.600 --> 00:16:18.320 might actually work for them, and we should like to think they will continue to be modest 181 00:16:18.320 --> 00:16:22.400 in the scale of their reserves additions once the new notes and coins are bedded in. 182 00:16:22.400 --> 00:16:29.040 Thus, barring de registe maladroitnes, we might accept Europe to start the year looking worse than the US, 183 00:16:29.040 --> 00:16:33.600 but possibly ending up with a much better balanced economy at the end of it. 184 00:16:33.600 --> 00:16:37.200 As for the UK, something of a local specialty, as you can hear from the accent, 185 00:16:37.200 --> 00:16:39.700 our pessimism should be well noted. 186 00:16:39.700 --> 00:16:44.940 Investment goods are in a 20-year slump and broader manufacturing is back at 1996 levels 187 00:16:44.940 --> 00:16:48.020 after a 1991 recession-style fall. 188 00:16:48.020 --> 00:16:51.940 Private non-financial returns on assets have fallen threefold since the Chancellor and 189 00:16:51.940 --> 00:16:55.940 the Bank of England Governor have presided over what they thought was an end to boom 190 00:16:55.940 --> 00:16:57.980 and bust policies. 191 00:16:57.980 --> 00:17:02.780 Bigger and bigger government, spreading industrial unrest, collapsing profits, scant saving 192 00:17:02.780 --> 00:17:07.740 investment, a huge trade deficit while borrowing a housing bubble in a softening private sector 193 00:17:07.740 --> 00:17:14.860 and the labour market looks all horribly reminiscent of 70s and 80s government inspired booms. 194 00:17:14.860 --> 00:17:20.460 Japan now seems categorically trapped between its Asian neighbours and the impotent US bully 195 00:17:20.460 --> 00:17:24.820 on the weary old ply of currency devaluation. Malaysia has threatened ructions, Korea has 196 00:17:24.820 --> 00:17:30.220 voiced complaints, China is flexing its muscles. The hope is that bank reform seems to be edging 197 00:17:30.220 --> 00:17:34.980 ever closer and if this is at last accompanied by a ruthless extirpation of the dead wood 198 00:17:34.980 --> 00:17:58.380 To recap, the core scenario is an increase in US GDP as the optimists have it, but with 199 00:17:58.380 --> 00:18:02.700 much higher prices than most give credit to and with far lower corporate profits except 200 00:18:02.700 --> 00:18:06.220 for those companies placed to gain windfalls from the effects of inflation. 201 00:18:06.220 --> 00:18:10.340 We see the Fed as being slow to react politically and tied by what is likely to be a continued 202 00:18:10.340 --> 00:18:14.540 upward march of unemployment and worried also about adding their impetus to the market's 203 00:18:14.540 --> 00:18:18.020 own imposition of increased debt service levels. 204 00:18:18.020 --> 00:18:22.500 Given its world view, it will be bamboozled by low factory utilization and a possible 205 00:18:22.500 --> 00:18:25.100 double dip in its precious inventory cycle. 206 00:18:25.100 --> 00:18:29.060 Greenspan's last speech showed that he was still irresponsibly trying to promote the 207 00:18:29.060 --> 00:18:33.520 The Monetization of House Price Inflation to support consumption, but how far this can 208 00:18:33.520 --> 00:18:36.820 run has to be questioned. 209 00:18:36.820 --> 00:18:42.360 In sum, we currently hold that the vast monetary stimulus will push up prices even amid stagnation 210 00:18:42.360 --> 00:18:45.720 in output and cost of living indexes will deteriorate. 211 00:18:45.720 --> 00:18:50.020 Before too long the yawning hole left by the evaporation of bubble tax revenues and their 212 00:18:50.020 --> 00:18:54.540 replacement with bust expenditures at every level of government will take effect not only 213 00:18:54.540 --> 00:18:58.400 to add an underlying offer to bonds but to begin to remind people of the bad old days 214 00:18:58.400 --> 00:19:05.280 of the 1980s. However, it is conceivable that the ongoing fall of income, in the sense of 215 00:19:05.280 --> 00:19:10.240 a remunerated flow of valued goods and services wrought by the distortions of the boom, will 216 00:19:10.240 --> 00:19:15.320 mean that the inflationary currents become in essence hidden ones. The lack of earnings 217 00:19:15.320 --> 00:19:18.920 visibility as the current vogue has it, and the political and financial impediments to 218 00:19:18.920 --> 00:19:24.460 entrepreneurial activity may, and we emphasise the may, be too much for businessmen to respond 219 00:19:24.460 --> 00:19:27.460 The Central Bank has not gone to mere liquidity just yet, preferring instead to hold it on 220 00:19:27.460 --> 00:19:29.660 account and bide their time. 221 00:19:29.660 --> 00:19:33.860 If this occurs, consumer prices could still rise, and they will certainly outstrip producer 222 00:19:33.860 --> 00:19:37.940 prices, but they will not rise as fast as we have in our main scenario, and may even 223 00:19:37.940 --> 00:19:38.940 decelerate. 224 00:19:38.940 --> 00:19:43.480 Of course, this would give the central bankers greater leeway to remain lax for longer, and 225 00:19:43.480 --> 00:19:47.120 fixed income strategists would be sharpening off pencils and projecting even more lows 226 00:19:47.120 --> 00:19:48.820 in bond yields. 227 00:19:48.820 --> 00:19:52.520 It would be too late then for us to argue that we still have an inflation in a technical 228 00:19:52.520 --> 00:20:06.520 and that in an honest world prices would have fallen to bring labour materials and factors of production all back into balance or that we are already sowing the seeds of the next boom, bonds would have gained significantly at the expense of equities and pessimism would abound. 229 00:20:06.520 --> 00:20:18.520 So far this does not appear to be the case. Not only is money supply still growing and the weekly MBA housing purchase index making new highs, but there are signs of life in non-energy commodities such as metals and DRAMs and even freight futures. 230 00:20:18.520 --> 00:20:23.400 Futures, though we should be wary that some of this is due to restrictionism, not demand. 231 00:20:23.400 --> 00:20:28.280 Asian export volumes too have begun to level off after often precipitous falls. 232 00:20:28.280 --> 00:20:32.160 But conversely it is true that industrial production and capacity utilisation were yet 233 00:20:32.160 --> 00:20:37.320 lower in December, albeit barely, and that production has now declined for 15 straight 234 00:20:37.320 --> 00:20:41.040 months, wiping out two years' gains and losing the biggest percentage since the slump 235 00:20:41.040 --> 00:20:43.640 of 1982 in the process. 236 00:20:43.640 --> 00:20:47.040 Core intermediate goods prices fell faster in the last six months than at any time in 237 00:20:47.040 --> 00:20:49.040 in the past 28 years. 238 00:20:49.040 --> 00:20:52.240 The core crude price is at the bottom of a 14-year range. 239 00:20:52.240 --> 00:20:56.840 NEPM prices are up from a 52-year low barely, and the Philly Fed's version of these is 240 00:20:56.840 --> 00:21:01.080 only just recovering from its October 33-year low. 241 00:21:01.080 --> 00:21:05.200 Orders may have done somewhat better, but as companies such as Tyco reminded us only 242 00:21:05.200 --> 00:21:09.720 this week, orders can be cancelled, and in some categories such as non-defence capital 243 00:21:09.720 --> 00:21:16.040 goods, the highest of high order goods, we are still languishing at 1995 levels. 244 00:21:16.040 --> 00:21:20.360 If therefore there is still no great demand for producer goods, as these aggregates may 245 00:21:20.360 --> 00:21:25.700 be suggesting, there is likely to be no payment to production workers or suppliers and, once 246 00:21:25.700 --> 00:21:30.760 credit led spending exhausts both itself and further free capital, if you like Jean's burn 247 00:21:30.760 --> 00:21:35.200 rate for the whole economy, the spiral into the depths well inside the production frontier 248 00:21:35.200 --> 00:21:39.360 would become all too real a possibility, as consumer goods too began to lie unutilised 249 00:21:39.360 --> 00:21:43.800 at the price and the process of voluntary postponement of purchases set in. 250 00:21:43.800 --> 00:21:47.120 Hayek's secondary depression could then be given an outing. 251 00:21:47.120 --> 00:21:52.760 It would be a shame if it does that the Fed has already expended so much ammunition trying for the mirage of a soft landing 252 00:21:52.760 --> 00:21:57.560 that it might be forced to resort to some real monetary crank methods to solve this problem 253 00:21:57.560 --> 00:22:01.960 given the crushing indebtedness which obtains across all sectors. 254 00:22:01.960 --> 00:22:06.920 We need then to see clear signs of reversal in these numbers together with the restoration of corporate revenues, 255 00:22:06.920 --> 00:22:09.080 profits we can wait upon for a short while, 256 00:22:09.080 --> 00:22:13.640 which might signal that the productive structure is lengthening or at least broadening once more. 257 00:22:13.640 --> 00:22:17.320 Drawdowns in institutional money funds would also be another signal of an end to a scramble 258 00:22:17.320 --> 00:22:20.520 for liquidity in favour of the activation of these balances. 259 00:22:20.520 --> 00:22:24.960 But until then, we are unfortunately in limbo, and we must invest with even greater than 260 00:22:24.960 --> 00:22:27.780 usual levels of deliberation. 261 00:22:27.780 --> 00:22:32.720 In the end, this episode may simply come down to what we all know in our hearts as the crux. 262 00:22:32.720 --> 00:22:41.040 After a truly spectacular boom and bust, will secularly expensive bonds win out over historically 263 00:22:41.040 --> 00:22:48.040 Or in other words, will the damage done to the system spare us from inflation's ills, even at the expense of a depression? 264 00:22:48.040 --> 00:22:54.040 This is what we, traders, speculators, entrepreneurs, must attempt to gauge in the coming weeks and months. 265 00:22:54.040 --> 00:23:00.040 And as acting men and women, we of all people should know that as the data change, so must we. 266 00:23:00.040 --> 00:23:06.040 That is the way to cope in a bear market, but it is of course also the way to cope in a bull market. 267 00:23:11.040 --> 00:23:13.040 Thank you for watching.