G.U.L.P.

I'm going to try to grab my 15 minutes of fame by fashioning my own acronym for what is going on here: G.U.L.P. It stands for Great Unwinding of Liquidity Period--let us pray that is merely a 'period' rather than an era. It also works because it has a nice double entendre meaning--most investors positioned heavily long are likely gulping and blinking in disbelief.

To the left is an image of a dung beetle (Scarabaeidae). The female pushes little balls of dung in which she lays her eggs. The dung is a stockpile of nutrition and nourishes the hatchlings. The ancients were keen observers of nature, and the industry and efficacy of these efforts were not lost upon them. You can find a brief and interesting synopsis here.

While dung balls work very well for this industrious member of the insect family, I'm not sure how well it will work for the saving of our financial system. I see lots of dung balls being rolled about, and who is to know how many eggs are being laid and what great magnitudes of beetles will hatch? Get some bug spray.

On Real Money last Thursday or so, I posted a thought about a very likely recalibration of historical price to earnings ratios in light of this GULP. Prices are always about supply and demand. Liquidity is always in the background as it influences the level of demand and provides the elasticity in equations that map the price reaction. (I may have that totally wrong, but it made sense at the time I'm writing it!)

Demand + Liquidity = Higher Asset Prices (inflation). Demand without sufficient liquidity is brings about a tempering of prices (disinflation). And the grimmest specter of them all, declining demand coupled with severely contracted liquidity brings about deflation.

Why is deflation bad? Here is the Nikkei since 1985. I would also say that this chart is also a reminder of why buy and hold is not such a great idea either.



Here's a bit from Wikipedia, which states it much more simplistically than I ever could.

Deflation is generally regarded negatively, as it is a tax on borrowers and on holders of illiquid assets, which accrues to the benefit of savers and of holders of liquid assets and currency. In this sense it is the opposite of inflation (or in the extreme, hyperinflation), which is a tax on currency holders and lenders (savers) in favor of borrowers and short term consumption. In modern economies, deflation is caused by a collapse in demand (usually brought on by high interest rates), and is associated with recession and (more rarely) long term economic depressions.

It seems to me that as economic units (earners, investors, spenders, savers, etc) each of us has to make some sense about what the future is to bring for us. There are so many smart people saying "this" or "that" or something in between the two, that it certainly leaves one scratching their head (or impolite places like the baseball players). As a person of reasonable intelligence trying to navigate unreasonable complexity, I have rely on something that never fails to serve: common sense. I'll make a bold statement, too, that common sense may not necessarily be in line with prevailing wisdom.

I'm not in a position to detail where the fissures lie between common sense and prevailing wisdom, but I know that I have a personal responsibility to investigate. Prevailing wisdom is that you buy when there is blood in the streets. Well, a look at the Nikkei chart shows that if you do that, you'll become your own little rivulet tributary. Prevailing wisdom in this market all year was to buy the dips and sell the rips. Well, the waterfall dips have been many. I expect a huge counter rally, but does the news support a sustained rally?

You'll see in my tabs a link to Paul Krugman's articles on Japan. I plan to read these. I'm feeling like I have to read and digest deflation 'stuff', much as I had to read and digest systemic risk and structured obligation 'stuff'. It was worth my time then. I think that it will be worth my time now. And I'll share what I find and hope it will beof use.