CONFIDENTIAL

The most important question facing business owners and investors today
December 2010

DEFLATION OR INFLATION?

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DEFLATION OR INFLATION?

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

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DEFLATION OR INFLATION?
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 social fabric of society will likely be stretched, challenging existing political systems and currency regimes 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)

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DEFLATION OR INFLATION?
SUMMARY CONTINUED 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?

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THE GREAT MODERATION

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THE GREAT MODERATION

Until the late 90s, the money supply grew in line with the real economy. But following the Asian and LTCM crisis, money growth significantly outpaced economic growth

Real GDP vs. M2 Money Supply Index

275 250 225 200 175 150 125 100 75 90 93 96 M2 Index 99 02 Real GDP 05 08

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

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THE GREAT MODERATION

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
Total Capacity vs. Real Personal Consumption Expenditures
170 160 150 140 130 120 110 100 90 90 93 96 Total Capacity 99 02 05 08

Real Personal Consumption Expenditures

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

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THE GREAT MODERATION

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

US 10-Year Treasury Yields vs Inflation (CPI)

16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0
Jan-80 Jan-83 Jan-86 Jan-89 Jan-92 Jan-95 Jan-98 Jan-01 Jan-04 Jan-07 Jan-10

-2.0

10-Year Treasury Yields

Inflation (CPI)

Source: Bloomberg, Bienville Capital Management, LLC,

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DEFLATIONWILL IT HAPPEN HERE?

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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

Contraction Cycle Peak August 1929 May 1937 November 1948 July 1953 August 1957 April 1960 December 1969 November 1973 January 1980 July 1981 July 1990 March 2001 December 2007 Cycle Trough March 1933 June 1938 October 1949 May 1954 April 1958 February 1961 November 1970 March 1975 July 1980 November 1982 March 1991 November 2001 June 2009 in GDP -27.0% -3.4% -1.7% -2.7% -3.2% -1.0% -0.2% -3.1% -2.2% -2.6% -1.3% -0.2% -4.1% Length 43 13 11 10 8 10 11 16 6 16 8 8 18 Monetary 3.4% 0.0% -2.2% 0.7% 0.3% 0.9% 0.4% 0.3% 1.0% 1.3% 22.1%

Stimulus as % of GDP Fiscal 4.9% 2.2% 5.5% -1.4% 3.2% 1.0% 2.4% 3.1% 1.1% 3.5% 1.8% 5.9% 11.9% Total 8.3% 2.2% 3.3% -1.4% 3.2% 1.7% 2.7% 4.0% 1.5% 3.8% 2.8% 7.2% 31.0%

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

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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

US PCE Core Price Index (YOY)

12.0

10.0

8.0

6.0

4.0

2.0

0.0 60 65 70 75 80 85 90 95 00 05 10

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 Price Index 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 volatile measure is the core PCE price index which excludes the more volatile and seasonal food and energy prices
Source: Bloomberg, Bienville Capital Management, LLC

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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

US Employment Rate
11.0 10.0 9.0 8.0 7.0 6.0 5.0 4.0 3.0
Nov-98 Nov-00 Nov-02 Nov-04 Nov-06 Nov-08

Source: Bloomberg, Bienville Capital Management, LLC

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DEFLATION?
Therefore, labor costs are declining, intensifying deflationary pressures

US Unit Labor Costs Nonfarm Business Sector

(YOY % Change)
14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0
Dec-79 Dec-82 Dec-85 Dec-88 Dec-91 Dec-94 Dec-97 Dec-00 Dec-03 Dec-06 Dec-09

-2.0 -4.0 -6.0

Source: Bloomberg, Bienville Capital Management, LLC

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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

Money Supply M2 Index

(YOY % Change)
12.0

10.0

8.0

6.0

4.0

2.0

0.0
Nov-89 Nov-92 Nov-95 Nov-98 Nov-01 Nov-04 Nov-07

Source: Bloomberg, Bienville Capital Management, LLC

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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

Federal Reserve Consumer Credit Outstanding (in billions)

$3,000

$2,500

$2,000

$1,500

$1,000

$500

$0
Dec-09 Dec-19 Dec-29 Dec-39 Dec-49 Dec-59 Dec-69 Dec-79 Dec-89 Dec-99

Source: Bloomberg, Bienville Capital Management, LLC

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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

US Output Gap
4.0

2.0

0.0
Dec-89 Dec-91 Dec-93 Dec-95 Dec-97 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09

-2.0

-4.0

-6.0

-8.0

Source: Bloomberg, Bienville Capital Management, LLC

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THE LESSON OF THE 70S

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THE LESSON OF THE 70S

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

US Output Gap (1970-1980)

6.0

4.0

2.0

0.0 70 -2.0 71 72 73 74 75 76 77 78 79

-4.0

-6.0

Source: Bloomberg, Bienville Capital Management, LLC

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THE LESSON OF THE 70S

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

US Capacity Utilization (% of Total Capacity)

90.0

85.0

80.0

75.0 67 68 69 70 71

Source: Bloomberg, Bienville Capital Management, LLC

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THE LESSON OF THE 70S

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

Velocity of Broad Money (M2 Index)

1.80

1.75

1.70

1.65

1.60

1.55

1.50 59 61 63 65 67 69 71

Source: Bloomberg, Bienville Capital Management, LLC

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THE LESSON OF THE 70S

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

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

16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 60 63 66

Nixon de-links the end of Bretton Woods

69 72 75 78

Source: Bloomberg, Bienville Capital Management, LLC

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THE LESSON OF THE 70S

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 from investing in more productive capacity
US Government 10-Year Yield
16.0

14.0

12.0

10.0

8.0

6.0

4.0

Nixon de-links the end of Bretton Woods

2.0 62 64 66 68 70 72 74 76 78 80 82 84

Source: Bloomberg, Bienville Capital Management, LLC

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IS INFLATION BUILDING?

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IS INFLATION BUILDING?

WHAT IS INFLATION?
Inflation is a debasement of the currency. It isnt too much money chasing too few goods. Its simply too much money

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IS INFLATION BUILDING?
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

CPI Owners Equivalent Rent (YOY)

7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 83 -1.0 86 89 92 95 98 01 04 07

Source: Bloomberg, Bienville Capital Management, LLC

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IS INFLATION BUILDING?
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

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

4.0 2.0 0.0 Dec-68 -2.0 -4.0 -6.0 -8.0 -10.0 -12.0 -14.0 Dec-73 Dec-78 Dec-83 Dec-88 Dec-93 Dec-98 Dec-03 Dec-08

Source: Bloomberg, Bienville Capital Management, LLC

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IS INFLATION BUILDING?
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

Federal Reserve Bank Total Assets

$2,500,000

$2,000,000

$1,500,000

$1,000,000

$500,000

$94 97 00 03 06 09

Source: Bloomberg, Bienville Capital Management, LLC

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IS INFLATION BUILDING?
Money supply has begun to rise

M2 Money Supply Index

$8,900

$8,800

$8,700

$8,600

$8,500

$8,400 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10

Source: Bloomberg, Bienville Capital Management, LLC

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IS INFLATION BUILDING?
Since Quantitative Easing began, food and energy prices are up nearly 50% while the CPI is reporting a only 2.9% cumulative increase

Crude Oil & CRB Food Index (Rebased to 100)

180

160

140

120

100 Mar-09 May-09 Aug-09 Crude Oil Nov-09 Feb-10 May-10 CRB Food Index Aug-10

Source: Bloomberg, Bienville Capital Management, LLC

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IS INFLATION BUILDING?
While hard currencies have also risen significantly, reflecting a debasement in the US dollar

Appreciation versus US Dollar (March 2009 November 2010)

60%

50%

40%

30%

20%

10%

0%
Australian Dollar Brazilian Real Canadian Dollar Singapore Dollar Gold

Source: Bloomberg, Bienville Capital Management, LLC

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CONCLUDING THOUGHTS

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CONCLUDING THOUGHTS

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

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CONCLUDING THOUGHTS
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 ask yourself, Are you prepared for the inverse of this chart?
US Government 10-Year Yield
16.0 14.0 12.0 87 Crash 10.0 8.0 6.0 4.0 2.0 0.0 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 S&L Crisis / Gulf War I Mexican Peso Crisis Russia Default / LTCM Failure Dot.com Bust 9-11 Subprime Credit Crisis Penn Square Bank Failure Continental Illinois Failure

Source: Bloomberg, Bienville Capital Management, LLC

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CONCLUDING THOUGHTS
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?

Gold (in USD)

1,600 1,400 1,200 1,000 800 600 400 200 0 01 02 03 04 05 06 07 08 09 10

Source: Bloomberg, Bienville Capital Management, LLC

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CONCLUDING THOUGHTS
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?

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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 cullen.thompson@bienvillecapital.com Donald Stoltz donald.stoltz@bienvillecapital.com

www.bienvillecapital.com

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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 or a 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 relied upon. 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.

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