deflation or inflation (december 2010)

7/31/2019 Deflation or Inflation (December 2010)

1/37

CONFIDENTIAL

DEFLATION ORINFLATION?The most important question facing business owners and investors today

December 2010


2/37

Deflation or Inflation?| 2

CONFIDENTIAL

DEFLATION ORINFLATION?

I have yet to see any problem, however complicated, which, when looked at the right

way did not become still more complicated.- Poul Anderson, author


3/37


CONFIDENTIAL


The disinflationary boom that existed between 1982 and 2007 has ended. This period, widely known as the Great

Moderation, was highly beneficial to asset prices

Strangely, although the increase in the money supply outpaced economic growth over this period (Slide 6), it did not incite

higher consumer prices. This is largely because production capacity growth exceeded consumption (Slide 7)

The result was a relatively steady and prolonged decline in inflation and interest rates (Slide 8), which reduced the cost of

capital for businesses, as well as the discount rate used to value future cash flows for financial assets. A global asset boom

ensued

However, the boom was underpinned by an unsustainable amount of artificially cheap credit. As the credit bubble collapsed,

the authorities around the world, particularly in the US, responded in a disproportionate and unparalleled fashion in attempt

to forestall a debt deflation (Slide 10)

Yet despite the unprecedented monetary and fiscal stimulus, the rate of measured inflation continues to decline

(Slide 11) while the prospect of structurally high unemployment intensifies the current deflationary pressures (Slide 12).Productivity-focused businesses are also driving down wages costs (Slide 13) in order to protect profits

Even as the Fed embarks on successive rounds of Quantitative Easing, broad money supply is rising less than nominal GDP

(Slide 14), while the velocity of money remains depressed

After years of accumulating debt, households are now in a deleveraging mode (Slide 15), an inherently deflationary process

that removes credit from the financial system

As a result, the economy is operating well below its estimated potential, resulting in a negative output gap (Slide 16)

EXECUTIVE SUMMARY

The ultimate outcome of the epic struggle between deflation and inflation is arguably one of the worlds most important questions.Asset prices, business profitability and sovereign creditworthiness will all be affected. If either occur to a significant degree, the socialfabric of society will likely be stretched, challenging existing political systems and currency regimes


4/37


CONFIDENTIAL


However, despite the current deflationary pressures, the 1970s illustrates how inflation can arrive unexpectedly.

Similar to today, the early part of the 70s also witnessed a negative output gap (Slide 18), low capacity utilization (Slide 19), a

declining velocity of money (Slide 20)

As a result, both inflation (Slide 21) and bond yields (Slide 22) were falling

Although there is no evidence of inflation in reported indices (Slide 25), todays policies could ultimately be highly

inflationary. The US government is running unprecedented budget deficits (Slide 26) while the Feds balance sheet will

soon triple from its pre-crisis size (Slide 27)

Recently, broad money supply has begun to pick up (Slide 28)

And since QE began, commodity prices have also risen significantly (Slide 29), as have other hard currencies relative to the

US dollar (Slide 30)

Today, the deflationary forces of the collapse of the credit bubble have been met with an unprecedented

inflationary response. Unfortunately, the ultimate outcome is unpredictable. Therefore, it is paramount that

investors and business owners to be aware of todays challenges, and where possible, protect themselves

sufficiently

Interest rates tend to move in long cycles. Both inflation and the cost of credit has been falling for nearly 30 years (Slide 33).

As a business owner or investor, are you prepared for a prolonged reversal?

As the inflationary response has grown, the public has been losing confidence in uncollateralized paper money. Gold has

risen to all-time highs (Slide 34). Is it anticipating another Great Inflation?

SUMMARYCONTINUED


5/37

CONFIDENTIAL

THE GREAT MODERATION


6/37


7/37


CONFIDENTIAL


Ordinarily, excessive money growth would have ignited consumer prices. However, beginning in the mid-90s, capacity grew

faster than consumption, which served to mitigate consumer prices. Other factors contributed to the macroeconomic

tranquility. As a result, the monetary inflation appeared instead in asset prices

Source: Bloomberg, Bienville Capital Management, LLC, Fielder Research & Management

90

100

110

120

130

140

150

160

170

90 93 96 99 02 05 08

Total Capacity vs. Real Personal Consumption Expenditures

Total Capacity Real Personal Consumption Expenditures


8/37


CONFIDENTIAL


Both inflation and interest rates fell resulting in a lower cost of capital and therefore higher economic profits for businesses.

Additionally, lower interest rates increased the prevent value of future returns on assets. It appeared to be Goldilocks

Source: Bloomberg, Bienville Capital Management, LLC,

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

Jan-80 Jan-83 Jan-86 Jan-89 Jan-92 Jan-95 Jan-98 Jan-01 Jan-04 Jan-07 Jan-10

US 10-Year Treasury Yields vs Inflation (CPI)

10-Year Treasury Yields Inflation (CPI)


9/37

CONFIDENTIAL

DEFLATIONWILL IT HAPPEN HERE?


10/37


CONFIDENTIAL

DEFLATION?

By every measure, the fiscal and monetary response today is disproportionate and unprecedented in history, nearly 4 times

the response of the Great Depression where real growth contracted considerably more

Source: Blackstone; Alan S. Blinder; Mark Zandi; The National Bureau of Economic Research; Lombard Street Research;Bienville Capital Management, LLC estimates

Contraction

Cycle Peak Cycle Trough in GDP Length Monetary Fiscal Total

August 1929 March 1933 -27.0% 43 3.4% 4.9% 8.3%

May 1937 June 1938 -3.4% 13 0.0% 2.2% 2.2%

November 1948 October 1949 -1.7% 11 -2.2% 5.5% 3.3%

July 1953 May 1954 -2.7% 10 - -1.4% -1.4%

August 1957 April 1958 -3.2% 8 - 3.2% 3.2%

April 1960 February 1961 -1.0% 10 0.7% 1.0% 1.7%

December 1969 November 1970 -0.2% 11 0.3% 2.4% 2.7%

November 1973 March 1975 -3.1% 16 0.9% 3.1% 4.0%

January 1980 July 1980 -2.2% 6 0.4% 1.1% 1.5%

July 1981 November 1982 -2.6% 16 0.3% 3.5% 3.8%July 1990 March 1991 -1.3% 8 1.0% 1.8% 2.8%

March 2001 November 2001 -0.2% 8 1.3% 5.9% 7.2%

December 2007 June 2009 -4.1% 18 22.1% 11.9% 31.0%

Stimulus as % of GDP


11/37


CONFIDENTIAL

DEFLATION?

However, as the structure of credit has collapsed, disinflationary pressures have persisted. Inflation has now been in a

downtrend for 30 years and is currently below the level considered to be price stability by the Fed

The PCE price index is a United States-wide indicator of the average increase in prices for all domestic personal consumption. It is indexed to a base of 100 in 2005. Using a variety of data including U.S. Consumer PriceIndex and Producer Price Index prices, it is derived from the largest component of the Gross Domestic Product in the BEA's National Income and Produce Accounts, personal consumption expenditures. The less volatilemeasure is the core PCE price index which excludes the more volatile and seasonal food and energy prices

Source: Bloomberg, Bienville Capital Management, LLC

0.0

2.0

4.0

6.0

8.0

10.0

12.0

60 65 70 75 80 85 90 95 00 05 10

US PCE Core Price Index (YOY)


12/37


CONFIDENTIAL

DEFLATION?

With significant slack in the labor force, workers dont have pricing power. Rather, employers continue to drive

productivity increases in the hopes of squeezing more out of fewer workers


3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

11.0

Nov-98 Nov-00 Nov-02 Nov-04 Nov-06 Nov-08

US Employment Rate


13/37


CONFIDENTIAL

DEFLATION?

Therefore, labor costs are declining, intensifying deflationary pressures


-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

Dec-79 Dec-82 Dec-85 Dec-88 Dec-91 Dec-94 Dec-97 Dec-00 Dec-03 Dec-06 Dec-09

US Unit Labor Costs Nonfarm Business Sector(YOY % Change)


14/37


CONFIDENTIAL

DEFLATION?

Despite the efforts of the Federal Reserve, broad money supply has been growing at rates below nominal GDP. The credit

creation process remains highly impaired


0.0

2.0

4.0

6.0

8.0

10.0

12.0

Nov-89 Nov-92 Nov-95 Nov-98 Nov-01 Nov-04 Nov-07

Money Supply M2 Index(YOY % Change)


15/37


CONFIDENTIAL

DEFLATION?

Deleveraging, which has only just begun in the household sector, is a highly deflationary process as it removes money and

credit from the financial system


$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

Dec-09 Dec-19 Dec-29 Dec-39 Dec-49 Dec-59 Dec-69 Dec-79 Dec-89 Dec-99

Federal Reserve Consumer Credit Outstanding (in billions)


16/37


CONFIDENTIAL

DEFLATION?

The output gap, an estimated measure of the US economys growth rate relative to potential, is still negative, implying

more deflationary pressure to come


-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

Dec-89 Dec-91 Dec-93 Dec-95 Dec-97 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09

US Output Gap


17/37

CONFIDENTIAL

THE LESSON OF THE 70S


18/37


CONFIDENTIAL


Similar to today, the output gap between 1970 - 1972 was negative, suggesting inflation was not a threat


-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

70 71 72 73 74 75 76 77 78 79

US Output Gap(1970-1980)


19/37


CONFIDENTIAL


Utilization rates had also fallen from the previous years levels, implying an abundance of capacity. However, despite the

overall economys excess capacity, bottlenecks were being created in critical sectors


75.0

80.0

85.0

90.0

67 68 69 70 71

US Capacity Utilization(% of Total Capacity)


20/37


CONFIDENTIAL


The velocity of money, a key ingredient to inflation, was also falling


1.50

1.55

1.60

1.65

1.70

1.75

1.80

59 61 63 65 67 69 71

Velocity of Broad Money(M2 Index)


21/37


CONFIDENTIAL


However, despite widely available economic data suggesting disinflation, the Great Inflation was unleashed in 1973


0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

60 63 66 69 72 75 78

US Consumer Price Index(YOY % Change, 1960 - 1980)

Nixon de-links the end

of Bretton Woods


22/37


CONFIDENTIAL


Similar to economic indicators, interest rates failed to anticipate the ensuing inflation, before subsequently rocketing higher

and peaking at nearly 16%. Higher borrowing rates decreased economic profits, which dis-incentivized business frominvesting in more productive capacity


2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

62 64 66 68 70 72 74 76 78 80 82 84

US Government 10-Year Yield

Nixon de-links the endof Bretton Woods


23/37

CONFIDENTIAL

IS INFLATION BUILDING?


24/37


CONFIDENTIAL


Inflation is a debasement of the currency. It isnt too much money chasing too few goods.

Its simply too much money

WHAT IS INFLATION?


25/37


CONFIDENTIAL


Conveniently, the Fed has shifted its emphasis from the PCE Deflator to Core CPI, which has a significantly larger weight

to Owners Equivalent Rent (OER). The implication is that actual inflation may be understated


-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

83 86 89 92 95 98 01 04 07

CPI Owners Equivalent Rent (YOY)


26/37


CONFIDENTIAL


Fiscal deficits, which are inherently inflationary, have exploded. Much of the increase is now structural, suggesting

politically difficult changes are required in order to reduce the annual deficit to sustainable levels


-14.0

-12.0

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

Dec-68 Dec-73 Dec-78 Dec-83 Dec-88 Dec-93 Dec-98 Dec-03 Dec-08

US Treasury Budget Deficit or Surplus(as a % of GDP)


27/37


CONFIDENTIAL


As a result of QE2, the Feds balance sheet will expand to nearly $3 trillion, or nearly 20% of GDP. The likelihood of

perfectly timing the removal of stimulus is small. However, the potential unintended consequences are large


$-

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

94 97 00 03 06 09

Federal Reserve Bank Total Assets


28/37


CONFIDENTIAL


Money supply has begun to rise


$8,400

$8,500

$8,600

$8,700

$8,800

$8,900

Sep-09 Dec-09 Mar-10 Jun-10 Sep-10

M2 Money Supply Index


29/37


CONFIDENTIAL


Since Quantitative Easing began, food and energy prices are up nearly 50% while the CPI is reporting a only 2.9%

cumulative increase


100

120

140

160

180

Mar-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10

Crude Oil & CRB Food Index(Rebased to 100)

Crude Oil CRB Food Index


30/37


31/37

CONFIDENTIAL

CONCLUDINGTHOUGHTS


32/37


CONFIDENTIAL

CONCLUDINGTHOUGHTS

Everyone has a game plan until they get hit in the mouth

- Mike Tyson


33/37


CONFIDENTIAL

CONCLUDINGTHOUGHTS

Interest rates have been declining for nearly 30 years. In response to each crisis, the Fed has used them as a tool to entice

borrowers to incur more debt and invest in more capacity. As an investor or business operator, it is imperative to askyourself, Are you prepared for the inverse of this chart?


0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

US Government 10-Year Yield

Penn Square Bank Failure

Continental Illinois Failure

87 Crash

S&L Crisis / Gulf War I

Mexican Peso Crisis

Russia Default / LTCM Failure

Dot.com Bust

9-11Subprime Credit Crisis


34/37


CONFIDENTIAL

CONCLUDINGTHOUGHTS

Today, gold is at all-time highs while interest rates are at generational lows. Both cannot be correct. Is gold anticipating

another great inflation? Or is it reflecting declining confidence in uncollateralized currencies?


0

200

400

600

800

1,000

1,200

1,400

1,600

01 02 03 04 05 06 07 08 09 10

Gold (in USD)


35/37


CONFIDENTIAL

CONCLUDINGTHOUGHTS

Given the magnitude of the current global imbalances and the enormity of the fiscal and monetary response, price

stability over the medium-to-long term is arguably the least likely outcome

Recently, deflationary pressures have had the upper hand. However, prices in critical assets and sectors are rising, and in

contrast to previous deflationary periods, today central banks have the ability and willingness to print money

Correctly positioning an investment portfolio or business for the inevitable outcome of either continued deflation or

significantly higher inflation is of critical importance, yet doing so too aggressively could prove disastrous should the other

unfold

Unfortunately, at this time, it remains impossible to accurately identify which side we will fall. Although higher

inflation seems more likely, flexibility remains key

As the analysis of the 1970s demonstrated, a significant inflation can occur with little-to-no warning signs. Estimated

outputs gaps were of no help. Anticipating it would have required a fundamental understanding of the likely ultimate

outcome of the policies implemented at the time

Ironically, the outcome of Quantitative Easing could have the inverse of its intended effectthat is, increasing the things we

need (i.e. commodities) which reduces real incomes and economic growth, while having only a negligible impact on the

things we already own (i.e. residential real estate)

We are at a critical juncture in economic history. Do you believe policymakers have the political will, as well as the

necessary foresight to successfully navigate todays challenging environment?


36/37


CONFIDENTIAL

FIRM AND CONTACT INFORMATION

Bienville Capital Management, LLC is an SEC-registered, independent investment advisory firm offering sophisticated and customized

investment solutions to high-net-worth and institutional investors.

The members of the Bienville team have broad and complementary expertise in the investment business, including over 100 years of

collective experience in private wealth management, institutional investment management, trading, investment banking and private

equity. We have established a performance-driven culture focused on delivering exceptional advice and service to a select number of

investors. We communicate candidly and frequently with our clients in order to articulate our views.

Our clients include individual and institutional investors, high-net-worth families with complex needs, entrepreneurs and professionals

with at least $1 million of investable assets. Bienville Capital Management has offices in New York, NY and Mobile, AL.

New York Bienville Capital Management, LLC

32 Avenue of the Americas, Ste 2100

New York, NY 10013

Phone: 212.226.7348

Alabama Bienville Capital Management, LLC

64 North Royal Street

Mobile, AL 36602

Phone: 251.445.8139

Email Cullen Thompson

[email protected]

Donald Stoltz

[email protected]

www.bienvillecapital.com


37/37

CONFIDENTIAL

DISCLAIMER

Bienville Capital Partners, LP (the Fund) is offered in reliance upon an exemption from registration under the U.S. Securities Act of 1933, as amended, for

offers and sales of securities that do not involve a public offering. This document is not intended to be, nor should it be construed or used as, an offer to sell ora solicitation of any offer to buy securities of the Fund. No offer or solicitation may be made prior to the delivery of the Confidential Private Offering

Memorandum of the Fund (the Memorandum). Securities of the Fund shall not be offered or sold in any jurisdiction in which such offer, solicitation or sale

would be unlawful until the requirements of the laws of such jurisdiction have been satisfied. No public or other market is available or is likely to develop for

securities of the Fund. Furthermore, securities of the Fund have limited withdrawal rights and are not transferable without the prior written consent of

Bienville Capital GP, LLC (the "General Partner"). Accordingly, an investment in the Fund is a relatively illiquid investment.

This document is confidential, intended only for the person to whom it has been provided, and under no circumstance may be shown, transmitted or otherwise

provided to any person other than the authorized recipient. While all information in this document is believed to be accurate, the General Partner makes no

express warranty as to its completeness or accuracy and is not responsible for errors in the document. Furthermore, the information is furnished as of the date

shown or cited, and the General Partner does not undertake any responsibility for updating the information herein. This document is provided for

informational purposes only, does not contain all material information about the Fund is subject to change without notice. Furthermore, estimates, investment

strategies and views expressed in this document are based upon current market conditions and/or may be based on information provided by unaffiliated third

parties.

In making an investment decision, investors must rely on their own examination of the Fund and the terms of the offering, including, but not limited to, the

merits and risks involved. The interests of the Fund have not been recommended by any federal or state securities commission or regulatory authority.

Furthermore, the foregoing authorities have not confirmed the accuracy or determined the adequacy of this presentation. Any representation to the contrary is

a criminal offense.

The information contained herein does not take into account the particular objectives or circumstances of any specific prospective investor and should not be

construed as accounting, legal, tax or investment advice. Prospective investors should consult their tax, legal, accounting or other advisors about the matters

discussed herein. An investment in the Fund may not be suitable for all investors and eligibility criteria will apply. No person has been authorized to give any

information or to make any representation, warranty, statement or assurance not contained in the Memorandum and any such information may not be reliedupon.

This document contains information about the Funds investment objective, programs, guidelines and restrictions. Material economic conditions, market forces,

and other factors may cause the Fund to adjust such objective, programs, guidelines and restrictions as necessary. No guarantee or representation is made that

the Funds investment programs, including, without limitation, its investment objectives, diversification strategies or risk management goals, will be successful,

and investment results may vary substantially over time.

AN INVESTMENT IN THE FUND IS A SPECULATIVE INVESTMENT, INVOLVES SIGNIFICANT RISKS AND IS SUITABLE ONLY FOR

THOSE PERSONS WHO CAN BEAR THE ECONOMIC RISK OF THE LOSS OF THEIR ENTIRE INVESTMENT AND WHO HAVE A LIMITED

NEED FOR LIQUIDITY. THERE CAN BE NO ASSURANCE THAT THE FUND WILL ACHIEVE ITS INVESTMENT OBJECTIVE.

deflation or inflation (december 2010)

Documents