“Appalling” Market Fundamentals, Not Inflation, Is The Problem

Fascinating discussion a few weeks ago in welling@weeden with Albert Edwards and James Montier of Societe Generale, reprinted with permission:


"In the cacophony that is global investment strategy research, Albert Edwards (that’s him, below left) and James Montier (on the right) stand out as clearly distinctive voices. And not merely  because of their British accents or because they’ve tended to the decidedly bearish side of the scale over the last decade or so. Despite long tenure in the rarified top echelons of the investment banking world, for many years with Dresdner Kleinwort and more recently at Societe Generale(where they are co-heads of global cross asset strategy) both have managed to retain a natural plain-spoken bluntness. Also large dollops of common sense and strong streaks of reflexive independence, which they employ in conveying their often invaluable insights on investment strategy. In Albert’s case, those spring mostly from his long experience in the dismal science of economics and in James’, from his explorations of the equally mysterious realms of behavioral neuroscience.

They are, in a word, skeptics, and at this juncture most deeply skeptical of any and all notions that “the worst is over.” The recession, which has barely begun, is more likely to be deep than shallow, market valuations are hideously expensive and the flation policymakers should be worried about starts with de-, not in-. 

For their reasons, keep reading, if you dare."



Inflation Not The Problem

Kate Welling

welling@weeden, May 30, 2008

Download 053008_Welling_Edwards-Montier_REPRINT.pdf


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What's been said:

Discussions found on the web:
  1. Philippe commented on Jun 25

    The Minsky cycle, increase of the debt burden when incomes or cash flows remain at best the same (remember the mantra leverage your balance sheet?) is now well introduced and Schumpeter has not shown his statistics yet, the great shame is it will not be contained to those whom deserve it the financial industry only.

  2. super-anon commented on Jun 25


    I started dumping zero coupon bonds earlier this year when long-time inflationists on other sites started talking about deflation.

    Now I’m not sure what to make of this.

  3. dave54 commented on Jun 25

    In this morning WALL STREET JOURNAL the AHEAD OF THE
    TAPE column was titled; “Food Shortage Recasts Image of
    Organic”… And after an analysis of Whole Foods vs Monsanto
    added this [irrelevant blurb?];

    In Fed Statement, Where Does ‘Risk’ Hide?
    The Federal Reserve will likely leave short-term interest rates
    alone at the end of a two-day policy meeting. Investors will hang
    on how the Fed announces its decision, looking for clues in its
    policy statement about what the central bank will do next.

    These announcements usually follow a template: A discussion
    of what’s happening with the economy and inflation, a brief
    statement on the risks to both and often a hint as to whether the
    Fed is leaning toward raising, cutting or leaving rates alone.

    If policy makers are more inclined to raise rates, they might flag
    “upside risks to inflation” or say the “predominant policy concern”
    is the risk that inflation won’t calm down. They used similar language
    last year. Or, if they’re in easier money mode, they might say
    “downside risks” to growth remain, as they did in March.

    Neither is likely. Instead, policy makers will probably echo their
    language on April 30, when they avoided talking about risk
    altogether, except the obvious statement that easy money
    would “mitigate risks to economic activity.” Anything more
    might box them in. And right now, they don’t seem to have a
    clear path in mind.

  4. Fullcarry commented on Jun 25

    I think people mis-understand sometimes how a wage price spiral can happen. Many third world countries experience this even when their economies are weak and job markets loose.

    The question is how much the individual values wages over other tangible benefits a job might have. They might substitute wages for holidays and/or flexibility. They might change jobs simply because the new employer pays slightly more or as is typical in many third world countries they start moonlighting as taxi drivers.

    Of course, wages are the most lagging of indicators. If the central banks wait until wages adjust to this increasing price level their subsequent tightening will be that much more severe.

  5. Mike in NOLA commented on Jun 25

    BR, thanks for this article. Makes me feel like not so much of a Jeremiah. Articulates a lot of what I have thought for a long time, but much better than I ever could.

    I suppose there’s no way for a small fry to get on their mailing list?

  6. S commented on Jun 25

    These guys are flat wrong about liquidity. Sure liquidity can evaporate overnight in an asset class but the statement ignores that liquidity is a fluid concept like a moving stream. Hence ttech, homes, commodities etc… Assuming their nomenclature, leverage, the extender of that leverage has debt. Debt is a future call on liquidity (money). So the road map eventually ends in the cul de sac of deflation. Whether you get hyperinflation first is an open question, and will depend on when the Fed deciddes to capitulate. At this point it is on its back and bridging as they say in wrestling. Where I can agree is that this will end very badly, but the whole liquidity argument holds no water. Unless I am misreading what they say…

  7. catman commented on Jun 25

    These two make Jeremy Grantham look like a shill for Fox Biz News. They are however cheeky and thought provoking. Thanks for the post.

  8. lex Grey commented on Jun 25

    I have been following Albert Edwards’ comments for a number of years now. Good to see such an in-depth interview. I did not realise that they think that the “…U.S. will eventually start to suffer something similar to Japan’s malaise, only worse … the U.S. economy’s greater flexibility …could lead to a much more violent death spiral on the downside than Japan ever had….” (Pages 12-13).

    This has been my view exactly for some time. Here is something I previously posted:

    I think that the unbalanced global economy (one with huge current account surpluses and deficits) is teetering on the brink of a major crisis because large current account surpluses and deficits are tied up with asset bubbles. In the former case (Japan and now China) the surpluses eventually cause bubbles whose bursting drives these economies into deep recession. In the latter (e.g. the U.S.), large current account deficits are only possible because of asset bubbles which are stoked by monetary policy. Monetary policy has to be so aggressive because of the economic weakness engendered with the shift in investment flows to China and India and other industrialising countries. The result is that domestic growth becomes more dependent over time on sectors where trade is not important. This also means that adequate growth is only possible because of asset bubbles (first the stock market bubble of the 1990s, then the housing bubble). Of course the end result of this is a deep recession as these asset bubbles burst. So growth in the U.S. over time becomes more precariously based.

    The situations of surplus and deficit countries are but two sides of the same coin and point to the unsustainability of an unbalanced global economy. However the world seems to be in a Catch-22 situation. The current growth path is unsustainable economy. Stephen Roach used to go at length about the need to rebalance the global economy and, in the current climate, was doubly worried about attempts to restore growth using the current model. Yet the large surplus countries (Japan, China) do not have the domestic demand to absorb their production. And the deficit countries (U.S.) are uncompetitive and would take years to rebuild their domestic manufacturing sectors.

    I am not clear what the end game of all this will be but it will not be pleasant for anyone. My best guess is that the global economy is entering a long period of crisis that will entail among other things:

    1) A deep recession in the U.S.;
    2) The fall of Japan back into recession and the ultimate failure of its policies to stabilise its economy (which have mostly succeeded in maintaining a holding pattern);
    3) The fall of China into a deep recession led by a bursting of first its stock market bubble (which is already happening) followed by a bursting of its real estate bubble;
    4) Global industrial restructuring in the face of a slump in worldwide demand (especially demand in the U.S.). This will accentuate the global slump.

  9. Andy Tabbo commented on Jun 25

    It’s scary. These guys are saying the exact same things I’ve been saying and blogging, that deflation is the real issue. I try not to discuss economics or the market at cocktail parties, because people become visibly uncomfortable. Nobody likes to hear that we’re heading for an economic depression and severe decline in the indexes. So now I just pretend everything is ok…but recommend to clients and friends maximum exposure to S&P puts.

    bouncy bouncy on S&P 500 today….looking for a bounce back to 1372-1388 zone…which is a sell.

    – AT

  10. scorpio commented on Jun 25

    along w Soros talking about an end to the 25-year “super-bubble”. i think that’s the crucial point: laissez-faire capitalism had another moment in the sun, like US in the ’20s, and now we’ve reached the logical extreme of concentrated wealth and nearly-unlimited poverty. this will be nasty

  11. David commented on Jun 25

    BR, Thanks for the post. I am an economic flyweight but this article is a personal confirmation on my expectations. Deep downturn which feeds on itself. I just can not logically think of any other outcome due to the size and scope of the credit expansion of the recent past.I have seen a lot of charts on the size of this credit bubble and from what I can gather this is by far the biggest credit bubble in history.

    My plan of action……get out of debt. I have been working on this for over 1 year with very good results.

    Unfortunately a lot of Americans are trapped in a debt lifestyle and are not fiscally able to extract themselves.

    We are living in very interesting times indeed.

  12. michael schumacher commented on Jun 25


    Promised a review of a DVD last week, here it is:

    America: Freedom to Fascism
    Aaron Russo (he was a producer on Trading Places- a favorite of mine and I’m sure of many here)

    It’s a two part presentation (on one disk) The IRS and Fed

    It covers the creation of the IRS in the first part of the documentary-wayyyyyy boring as it interviews tax dodgers and former agents in a fashion that appeals to the uninformed and sensation mongers- has a few tidbits and interesting points of view however you may want to skip it if you are like me and already knew the 16th amendment was never actually ratified by the states…..it sort of fixates on that aspect of it so if it’s news to you… you might want to watch it-simply for the comic relief interview with a former IRS commissioner (Sheldon Cohen??) His standpoint is that a supreme court ruling from 1920 (or so-his words) can’t be applicable in the “real world of today”….he pretty much ends the interview at that point.

    The Fed piece was the better of the two…again there is not much new information here : tackles the gold standard, fiat currency (but not by that name), what is really classified as money etc. There are several other pieces that sort of go with the overall theme of why the Fed was created: Patriot Act, RFID tracking (via the National I.D. card), and basic civil liberty infringement’s that have been associated with the, ahem…..current administration.

    The best quote (been unable to verify it) was “The constitution is just a goddamn piece of paper”-GWB, sometime in 2005

    Towards the end it really lost me as a Michael Moore(ish) creating fear of the gov’t when it really did not need to do it.
    The seperate pieces do a good enough job of allowing that to occur (if you actually analyze things-what a concept!).

    I’ll give it a 7 out of 10….and it gets a higher rating than normal simply because it tackles some issues that are not at all discussed in the MSM- if not for that it would have been a 5-6. Worth your time as an augmentation to things you probably already know but are re-enforced.

    I will say that if you watch it and get your news from say Fox or WSJ, CNBC then you are going to hate it…..you will label it as complete propaganda. I understand that but I do not condone it.


  13. Steven commented on Jun 25

    It’s nice to read an analysis to which I can relate (confirmation bias?).

    The biggest problem is timing and the sequence in which various actors (central banks, sovereign wealth funds, legislative fiscal bailouts) engage the economic condition.

    If the Fed persists in lowering the interest rate before the energy bubble pops then that bubble will just continue to grow until the Fed has no remaining ammunition (and then it will pop). Such action by the Fed would also feed into a wage-price spiral in emerging markets on foreign currency pegs to the $USD and the USA will continue to import that inflation. But at some point within the next two years there’s going to be a real adjustment to the entire global economy from which no country escapes a downturn.

  14. wally commented on Jun 25

    Thanks for posting this – it is very thought provoking.

  15. michael schumacher commented on Jun 25

    One thing I left off of the review:

    It does a good job of looking at the Grace Commission and the “issues” that created in the early to mid 80’s.


  16. Matt M. commented on Jun 25

    I didn’t catch the two gentlemen’s performance numbers.

    Can somebody help me out with that?

  17. Peter commented on Jun 25

    So, is this week’s doubling of iron ore prices consistent with an emerging market slowdown?

  18. Risk Averse Alert commented on Jun 25

    Should “appalling fundamentals” be your big “Aha!” were a bust to unfold over the next couple weeks … forget not $3.5 trillion clams and the City’s plan to elect the man President who can be most easily destroyed … so, again you might say “Aha!” as the market melts up, despite “appalling fundamentals,” going into 1/20/09 inauguration…

  19. ward dahlgren commented on Jun 25

    One of the best reviews I’ve seen. thanks for the link

  20. Sam commented on Jun 25


    This long discussion integrates many themes that are current in the discussion of the forces at work in the markets. I believe the Edwards/Montier distillation to be an important contribution to an understanding of what gives.

    Thanks for this most important article.


  21. Rock commented on Jun 25

    I’m going to have to read this article more than once to get everything out of it :)

    This is just the kind of good stuff I expect/hope from a macroeconomic blog.

  22. GreenAB commented on Jun 26

    great interview, thanks for posting!

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