The Dog Which Has Not Barked?

Michael Klimes of Professional Pensions reports, Deflation is the ‘dog which has not barked’:
Fears of deflation have been exaggerated since the 2008 financial crisis according to former Bank of England (BoE) monetary policy committee member Andrew Sentance.

Speaking at the Workplace Pensions Live 2016 conference, Sentence described deflation as "the dog which has not barked" as he expects inflation to rise to around 1% or 2% in the near future from its current low levels, with 0.5% recorded in March.

"We are not in a deflationary world; growth is not far away from the long-term average," he said.

The pattern of growth in the global economy is shifting as emerging market growth falls back to an average of 4% to 5% while it picks up in the West to just over 2% a year.

"Divergence [between developed and emerging economies] means some economies are doing quite well. These differences in growth are not set to go away quickly," he added.

Sentence also explained what he terms the "post-crisis new normal economy" where the UK has record levels of unemployment despite lower than anticipated growth since 2008.

"Employment has picked up, particularly in the UK and Germany. There is a bit of mismatch where growth has been picking up in the West and has been relatively low with unemployment at boom time conditions. What reconciles those two positions is poor productivity growth," Sentance continued.

Such conditions presented investment opportunities for pension funds in technology, demographic shifts and structural changes in the economy.

However, "in this new normal, you need to be much more selective and work out where the investment opportunities lie," he warned.

Sentence is senior economic adviser to PwC.
I found this interesting because it made me think, maybe I'm totally wrong about the deflation tsunami I've long been warning of. Maybe the bond market has it wrong and ultra low and negative rates are not here to stay. And maybe the Governor of the Bank of Canada was wrong to warn pensions to brace for lower rates.

Or maybe not. Sentence is a well-known "arch-hawk" who thinks interest rates are too low and the big nemesis remains inflation, not deflation. In my opinion, he's completely off track. Everywhere I look, I see global deflationary headwinds picking up steam.

Earlier this week, the Telegraph's Ambrose Evans-Pritchard reported the eurozone’s short-lived recovery is already losing steam as stimulus fades and deep problems resurface, raising fears of yet another false dawn and a potential deflation trap if there is any external shock over coming months (read his article here).

In Japan, persistent deflation has some economists inside and outside the country, including former Federal Reserve chairman Ben Bernanke, now debating extreme policies from “helicopter money” to forced wage increases. Such ideas once seemed to be for textbooks only — but as Japan languishes, the country could become a laboratory for economic experimentation.

No wonder many analysts now think the European Central Bank and Bank of Japan may soon be spending as freely on shares as they already are on bonds, especially if the weapons so far deployed from their monetary policy arsenals continue to fire blanks.

In the rest of Asia, the IMF warned Singapore’s central bank should be ready to adjust its monetary policy further if deflation takes root in the city state. In Australia, some are bracing for more cuts to interest rates as deflation takes hold.

In China, consumer inflation remained modest in April, while producer prices' four-year slump moderated as commodity prices rebounded, easing concerns about deflationary risks to the world's second-largest economy, but this might be a temporary reprieve as China's hard landing is spreading to Hong Kong.

I can go on and on but the point I'm trying to make is deflation, not inflation, remains the biggest single problem in the world today. When you add to this the demographic shift and the huge debt overhang, it's not exactly a pretty long-term picture.

In my comments on deflation, I always focus on six structural factors exacerbating global deflation:
  1. The global jobs crisis
  2. The global pension crisis
  3. The global debt overhang (high and unsustainable debt)
  4. Aging demographics
  5. Rising and pervasive inequality which hampers aggregate demand
  6. Technological shifts impacting consumer spending (Amazon, Uber, etc)
Interestingly, Bloomberg reports that Americans are breaking the record for working past the age of 65 with many saying they will 'never retire'. The main reasons? Some are healthy, like their job and don't want to retire but most can't afford to retire because they haven't saved enough, can't rely on their meager 401(k)s to retire and they don't have access to a defined-benefit plan.

The people able to work past the age of 65 are a minority and part of the lucky few. Most Americans retire in poverty and this is a looming public policy catastrophe which will impede growth and raise the debt. Worse still, the revolutionary retirement plan being peddled by some experts to address this crisis will only benefit Wall Street, not Main Street (what else is new?).

My point is the world isn't in great shape and even in the United States, there are serious structural issues which will exacerbate global deflation.

What about oil? Oil prices have rebounded and are looking good for the global recovery. This is true but I see no confirmation of this so-called global recovery in the world's major bond markets. Also, lots of speculation going on in oil right now with Glencore apparently trying to manipulate 30% of the supply.

I don't know if this is true but Glencore and Vitol are near a deal to buy Iranian oil, Glencore has hired the bulk of Noble's London gasoline team in its effort to play big in the fuel oil market, and it's been telling people the resurgence in mining shares this year may be just getting started.

Given my views on global deflation, I wouldn't bet on any resurgence in metal and mining shares (XME) and quite honestly, I don't trust anything Glencore has to say on oil or mining shares.

Interestingly, Glencore is now in talks to sell a further 9.9 percent stake in its agricultural unit:
The company is said to be negotiating with bidders who missed out on the 40 percent sold to Canada Pension Plan Investment Board.

Bidders include a different Canadian pension fund, state-backed Saudi Agricultural and Livestock Investment Co. and Qatar’s sovereign wealth fund, the sources said.

The CPPIB agreed last month to buy a 40 percent stake in the unit, which includes Viterra, for $2.5 billion, placing the equity value of the business at $6.25 billion. 

The unit is valued at closer to $10 billion when inventories and debt are included. 

The 9.9 percent stake is valued at around $625 million.

Glencore had been aiming to close the deals at the same time in the second half of 2016, the sources said.

“Negotiations are ongoing,” one said. “People who lost out are still trying to get on board, but Glencore will struggle to get more money for it.” 

The company announced its intention to sell a minority stake in its agricultural unit in September, after shareholder pressure to see it cut debt prompted a slew of measures including asset sales, reducing capital expenditure and suspending dividend payments.
Maybe Glencore will use the proceeds to corner the oil market. /sarc

Anyways, back on topic. I don't see any resurgence in commodities for a simple reason, global deflationary headwinds are picking up steam and they will pick up more as the US dollar gains on other currencies in the second half of the year (Note: A strengthening USD will alleviate deflationary pressures elsewhere but it means the US will be importing more deflation, which isn't good).

Despite what Jeffrey Gundlach thinks, I don't see the Fed raising rates this year and I partially agree with Steven Ricchiuto, chief economist for Mizuho Securities, the Fed is blowing it because it thinks the economy could be overheating, but the real problem is excess supply and deflationary pressure:
“The dynamics of supply and demand have shifted,” Ricchiuto said in an interview.

“I don’t think they get it yet,” he said of the Fed. The central bank is trying to manage the economy as if excess demand were still the major problem it was in the 1970s and 1980s. But today’s global economy suffers from a different imbalance, Ricchiuto says: Excess supply.

When excess demand is the normal state of the economy, then inflation is the perennial problem. But if the economy is stuck in a rut of excess supply, then slow growth and deflation will persist.

“We should be immunizing the nation against deflation,” Ricchiuto said. But, instead, the Fed still seems to be living in the 1970s, worried that the unemployment rate will go too low and that the economy will overheat. That’s why the Fed “blew it in December” when it raised interest rates.

The myopic focus on unemployment is misguided, in Ricchiuto’s view.

Almost all of the economic data on the production side of the economy (such as industrial output, business sales and gross domestic product) show a tepid economy. But the labor market is doing great, comparatively. The Fed reacts to the strong job news, but ignores the rest of the story.
I happen to think there is an excess supply story but there's also a deficient aggregate demand story compounding the deflation problem.

Who do I agree with? Larry Summers. Since losing out to Yellen in 2013, the Harvard economist has been jetting around the world—from Santiago to St. Louis to Florence, Italy—to argue that the world economy is in much worse shape than central bankers understand:
Focusing on monetary policy alone, he says, they’re doomed to fall short of reviving growth. They need to reach out to the governments they work for, he argues, and insist on strong fiscal stimulus in the form of infrastructure spending and the like
Take the time to read Summers's thoughts on how to pull the global economy out of its rut. The world has a serious problem and very few economists understand it and what needs to be done to address it.

I'll leave you on that note and warn you to ignore any economist who tells you "we are not in a deflationary world." This is pure nonsense and it's the type of thinking which has gotten the world stuck in the rut it's in.

Below, Larry Summers warns that pushing off repairs of America's crumbling infrastructure to future generations creates the "worst and most toxic" debts. He's absolutely right. America will fall $1.44 trillion short of what it needs to spend on infrastructure through the next decade, a gap that could strip 2.5 million jobs and $4 trillion of gross domestic product from the economy, a report from a society of professional engineers said on Tuesday.

Also, crude is poised to go lower, said oil expert John Kilduff, whose bearish calls on the commodity have been dead on. "I don't see this market coming into balance until at least Q1 of 2017, if not later," Kilduff told CNBC's " Worldwide Exchange " on Friday, a day after the International Energy Agency said global oil markets are heading toward a long-awaited equilibrium.

Third, Lacy Hunt, Hoisington Investment Management, joins CNBC's Rick Santelli to discuss weak economic growth and surging debt. Hunt thinks too much wrong debt is the cause of economic weakness and he states "the secular lows in Treasury yields are not in yet".

Lastly, FRA co-founder Gordon T. Long is joined by Satyajit Das in discussing the consequences of financial repression in the age of stagnation. Great discussion, listen to his comments.