Tuesday, August 3, 2010

Deflation Debate Rages as Fed Ponders QE2

Editor's Note: This is a post covering two days - Monday and Tuesday, August 2 and 3 - due to my summer schedule, which includes a late afternoon round of golf on Mondays. The market stats are for Tuesday.

For conspiracy theorists, the constant droning about deflation which began on Friday with St. Louis Fed President James Bullard appearing on "Squawk Box" in the aftermath of his paper, Seven Faces of “"The Peril”", seems ominous enough to conclude that the new master plan is to plunge the economy into a deflationary depression.

While that may or may not be so, there are some views that make future prospects - even with the deflation element added in - not quite so frightening, such as Jim Rickards' thought-provoking response to Paul Krugman that deflation can actually benefit the economy, though Gary North's Economic Warnings From Niall Ferguson and Nassim Taleb and the Golden Jackass (Jim Wilie CB) Kindergarten Double Dip Recession Economics offer less-rosy scenarios.

Of course, here at Money Daily, my position has been consistent - that we've been deflating since August of 2007 - running diametrically-opposed to the views of Puru Saxena, who boldly penned, Debunking the Mainstream Economists Deflation Myths, while neither establishing economic realities as "myths" nor debunking any deflationary tendencies.

For whatever it's worth, the view here is that deflation is a soluble way out of the financial conundrum and relatively painless for regular people who would like their dollars to stretch a little further. For those invested in non-liquid assets with malleable price structures, the result of prolonged deflation might not be so pretty, and could actually be quite messy, ending up in bankruptcy court, where, indeed, many of the mal-investments of the past 20 years belong.

Since the non-stop talking heads on CNBC can't seem to leave the topic alone, it's probably a good sign that deflation is well underway. Either that, or they're purposely trying to scare investors, for whatever nefarious purpose they or their corporate masterminds may have concocted. It wouldn't be the first time that the on-air talent at CNBC was so far behind the curve that it appeared as a straight line, nor will it be the last. One only has to recall the archives from the Fall of '08 for some fresh views of the then-shocked and dismayed countenances witnessing the market meltdown in unanticipated awe.

If deflation truly takes hold and begins a spiral downward - something oil certainly seems not to want to do - day-to-day changes in stock or market indices will become more and more irrelevant over the near term, as will the generally feeble attempts by the Fed to do anything about any part of the economy, except, that is, to make it worse.

A paragraph from Jim Wilie's latest article (linked above) sums up the current catastrophe nicely:
The chain of ignominy includes gaping blind spots, blatantly wrong forecasts, minimized ignitions that spread crisis, misguided focus on goofy indicators, outright removal of important indicators, sloppy deception of monetization efforts (see last week's article), clumsy justification of Wall Street welfare, backwards perception of Too Big To Fail banks, and lying before the USCongress. The nation is dominated by fools who profess the lasting benefits of 'Hand to Mouth' approaches like tax rebates, purchase credits, jobless insurance extensions, and helicopter drops. Their worst investments are their biggest investments, like Fannie Mae and AIG nationalizations travesties. Harken back only to last winter, when economists were talking about a second half recovery, running all the red lights and stop signs. Then they shifted the klapptrapp to claims of a jobless recovery, which should evoke laughter from its impossibility. The economic counsel has forgotten what capital formation means, while they prepare for their next tourniquet to be applied to hemorrhages. The objective of monetary policy and banking policy is not recovery, but instead very clearly to retain power.

What seems clear is the Fed's desire to re-inflate via Quantitative Easing once again, a plan that has largely failed once and continues to do so, with what has become known as QE2. Should the Fed decide to expand its purchases of Treasuries, agency and mortgage slush, the result will be more of the same: banks will hoard cash, consumers won't spend and the dollar will be reduced in value against other currencies, which, naturally, may be the Fed's plan in a nutshell.

Debasing the greenback may (probably) not stimulate the US economy, but it will have the effect of improving our trade balance if only by making exports cheaper. That benefit accrues mostly to multi-national corporations, the very same ones that have been reporting stellar second quarter results while the real world wallows in a sea of debt, fear and uncertainty.

They'll probably do it, and it will probably fail, deflation will rule, and the brainy folks who call themselves economists can all go scratch their collective heads. While inflation, according to Milton Friedman, is always a "monetary event," deflation will prov to be a global fiscal event with long-lasting implications.

On Monday, traders sent stocks soaring like the Yankees had just won the World Series, based upon some very suspect ISM numbers, which actually fell from the previous month and were only buoyed by the artificial stimulus of public sector (government) spending.

Tuesday saw no visible follow-through, a hint that the massive Monday rally was only a trading ploy, designed to maximize profits from shorting into Friday's non-farm payroll report. Stocks plummeted right off the open and spent the rest of the day underwater, partially recovering.

Dow 10,636.38, -38.00 (0.36%)
NASDAQ 2,283.52, -11.84 (0.52%)
S&P 500 1,120.46, -5.40 (0.48%)
NYSE Composite 7,146.99, -27.91 (0.39%)

Decliners led advancers, 4000-2430; new highs lead new lows, 361-73. Volume was downright pathetic, even for August.

NASDAQ Volume 2,011,883,125
NYSE Volume 4,551,798,500

Oil continued to confound, gaining $1.21, to $82.55, an overshoot of dramatic proportions. Gold gained $1.80, to $1,185.20, while silver was unchanged, at $18.41.

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