POTENTIAL BLACK SWAN: $10 OIL

 Mike Maloney of Gold and Silver Inc. got quite a bit of media attention (and flack, supposedly) for a speech he held at the 8th International Banking Forum in Sochi, Russia last year, as well as for the videos of the event that were posted on YouTube.

In the speech, Maloney told the assembled bankers they will soon be witness to events never before seen in the history of mankind, and that if they didn’t prepare, they’d all be working for their governments before long.

He also said oil would go down to perhaps as low as $10 per barrel (which closely resembles our contention that deflation will cause prices of assets, commodities etc. to fall by 80-90%). For those of you who haven’t seen the videos, they’re highly recommended viewing. They offer a very good description of the workings of our credit based monetary system, complete with technical analysis. Here’s Part 1, and here’s Part 2.

A few days ago, Maloney posted an update on the speech. And since his views are so -obviously- close to those we have here at The Automatic Earth, I thought it might be a good idea to talk about it a bit. Not in the least because Mr. Maloney gets just about everything right, and then ‘somewhat falters’ with the finish line in sight, simply since he can’t seem to keep himself from talking his book.

First, here’s the video (you may want to watch it after reading this essay). The title is $10 Oil Follow Up – The Case For Short Term Deflation.

So yes, Mike Maloney, just like us here at The Automatic Earth, predicts deflation followed by hyperinflation. Only, as far as I can see, he has more emphasis on the hyperinflationary period than on the deflationary period that will -of necessity, as we both realise- precede it. We do not. Here’s thinking that difference has a lot to do with him talking that book, which, after all, is gold and silver. As for us, we think that the coming (debt-) deflation will devastate our economies to such an extent that when hyperinflation arrives, it will feel silly, if not worse, to ever have focused on it -contradictory as that may sound-. In short, we see a world far more drastically altered down the road than Maloney seems to do.

Still, he has a lot of good points to offer:

Mike Maloney: “It could be that the foreclosures that we’ve already seen, and the crash of 2008, was the deflation, but I don’t think so, because there hasn’t been enough of the excesses cleared out of the system. We’re in this long term cycle, and there has to be what’s called a credit revulsion, where people just WILL not take on any more credit.

And to get to that point, they all have to get burned. More people have to lose their houses, more people have to lose their margin trading accounts, we need something that happens that will cause these excesses to be flushed out of the system.”

Ilargi: Maloney then goes on to state that you can’t have markets overvalued for a long time, “with P/E ratios in the stratosphere forever”. Markets, according to him, and it’s a great metaphor, are a voting machine in the short term (the whole crowd rushes in to one side, they all want paper assets), but they’re a weighing machine in the long term (i.e. they seek an equilibrium). Furthermore, “they always have to go to fair value, and then they overshoot it and they go to the opposite extreme”.

He follows this up by declaring that “there is a scenario where gold can go up while all these other commodities like oil are falling. In fact there are several such scenarios”. And that is probably where we diverge the most. And I’m thinking: we have no book to talk, we just have our “message to you Rudy”. What are the chances that Mike Maloney sees what he does because he looks through his book’s slightly distorted glasses?

Whatever’s the answer to that one, Stoneleigh and I can’t see how the price of gold -and silver- can hold up, let alone go up, if and when the very rounds of never-before-seen deleveraging and deflation Mike predicts come to pass. We think that it will force a huge amount of people who hold gold, to sell it into a buyers market. And those left standing afterwards will not be numerous enough to hold up the price either. It’s not that gold can’t reach $20,000, but that it can’t do so in today’s dollars. A subtle difference.

Mike then proceeds to go through a set of charts at the St. Louis Fed website that show the deflation going on. Note: he talks about what he labels “monetary deflation” (i.e. the definition of inflation/deflation as pertaining to the currency supply, not to rising prices). We of course simply call that deflation. I looked up some of the graphs he addresses, at the St. Louis Fed:

Commercial and Industrial Loans at All Commercial Banks – 80 years

chart

Mike Maloney: “Base money before the bail-outs was only $825 billion, $800 billion of that was the money in circulation, the rest were deposits that commercial banks have in their checking accounts at the Federal Reserve. Then Ben Bernanke bailed them out and he more than doubled the base money portion of the currency supply, but base money was a very small portion. The total currency supply is total outstanding credit, which is up in the $50 trillions. So $825 billion is nothing. You’re only talking about a few per cent of the currency supply that Ben Bernanke has direct control over. The rest of it, all the Federal Reserve can do is try and influence it; but to influence it, he’s got to make us feel good.”

Total Consumer Credit Outstanding – 80 years

chart

Ilargi: As you can see, the drop in the second graph, Consumer Credit Outstanding, is less dramatic than that in the first one, Commercial and Industrial Loans. That is to a large extent because of elasticity: it is far easier for banks to refuse new funding to companies than it is to grab back what consumers owe them.

Real Estate Loans at All Commercial Banks – 80 years

chart

Ilargi: For the same reason, Real Estate Loans are down less than Commercial and Industrial Loans.

Consumer (Individual) Loans at All Commercial Banks – 80 years

chart

Ilargi: And this one is just weird. As Mike Maloney says, it’s hard to find a more obvious sign of the Fed pumping “money” into the banking system. This becomes even clearer as we zoom in on the last six years:

Consumer (Individual) Loans at All Commercial Banks – 6 years

chart

Ilargi: Apparently, sometime in early 2010 American consumers, virtually overnight, decided to take out 50% more in loans than they already owed. And the banks let them. Right.

Commercial and Industrial Loans of Weekly Reporting Large Commercial Banks – 30 years

chart

Ilargi: What we see here is identical to what’s in the first graph, the not weekly reported Commercial and Industrial Loans: a decline of 25% in a period of maybe 20 months. That’s a lot. Don’t let’s forget that QE1 fell in this timeframe. Here’s the zoom-in:

Commercial and Industrial Loans of Weekly Reporting Large Commercial Banks – 6 years

chart

Ilargi: Sure, there seems to be a small uptick, presumably QE2 related, but it really only serves to illustrate how powerless a program QE2 has been. Remember what Mike Maloney said earlier: “[..] all the Federal Reserve can do is try and influence it; but to influence it, he’s got to make us feel good.” Moreover, look at the next graphs:

Total Revolving Credit Outstanding – 50 years

chart

Ilargi: No uptick here, the Total Revolving Credit Outstanding has been falling for 2.5 years now. Zoom:

Total Revolving Credit Outstanding – 6 years

chart

Ilargi: That is a drop of some 16-17%. And that spells deflation in any dictionary.

Mike Maloney: “What I’m saying is that deflation is actually happening and you got this grand, this epic play that’s happening right now, that’s unfolding in front of us, where for the first time in history the entire world is in this IOU-based currency system.

Every 30-40 years the world has a new currency system. Each system that is a man-made manipulated system can not account for all of the forces in the free market and energy builds up in certain areas and then the thing starts to self-destruct. That’s what we’re seeing right now. The Euro is such a poorly designed system that it barely lasted a decade and here it’s already self-destructing. We’re going to see all of these debt-based monetary systems self-destructing. There’s going to be in this decade some big emergency G-20 meeting where they’re going to hash out another world monetary system just like they did in 1944, Bretton Woods, New Hampshire.”

Ilargi: I full-heartedly agree with Mike that these graphs, which more or less cover the entire US currency supply (or are at least as close as you need to get for the purpose of distinguishing between inflation and deflation), paint a very clear picture of the deflationary time we are currently in. As for price rises in some areas: prices are a lagging indicator when it comes to inflation and deflation, they necessarily follow the currency (money and credit) supply. Hence: they WILL come down.

And yes, Maloney is right in saying that a lot more will need to happen before we reach the peak (or the trough, if you will) of this deflation. People will have to lose a lot more in home values, asset values, stocks, commodities, everything tangible. And then they will lose trust. Which is where “Credit Revulsion” will come in.

By then, however, and I’ve talked about this before, the number of people who could be called “investors” according to the definition of the term we use today, will of course plummet, by at least the same 90% that asset prices will. The revulsion will be widespread. And this is nothing new. There never was a time until quite recently when every mum and pop were investors. So we’ll only get back to normal, not away from it.

Still, that does not bode well for the price of gold and silver, a point Mike Maloney somewhat hesitantly tries to ignore. If, as we both expect, the vast majority of people lose the vast majority of their wealth, there will be a lot of gold for sale in “the market” (whatever it may look like by then). That means a huge amount of sellers, forced to sell by investment losses and other predicaments, and an ever shrinking number of potential buyers. Who might just be wise enough to wait for the price to come down further. It seems obvious where that leads.

But other than that, great videos, and very smart points. Thanks, Mike.

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