Here is a message from a Dear Reader from Australia who makes the case for deflation. (His first comment is about the Fed’s latest bailout):
“I think Bill Bonner has the wrong end of the stick. The Fed is not pumping in anything – it is an asset swap with the banks and other financial institutions whereby the Fed takes the unwanted mortgage backed securities (at a suitable discount) in return for lending its own high quality Treasury notes. These will then be negotiable as collateral to raise money. It is a neat trick to liquefy the debt market but in the process the Fed is taking on the risk that other banks do not want to accept. It will hope that the discount to valuation will cover the failures. In time it may even profit. The question is this – since this is a term lending facility, will the Fed in managing its credit risk ever pull the trigger on a major bank and demand re-payment? Are we witnessing a de facto nationalization of the U.S. banks?
“The point is that what the Fed is doing now is not inflationary – the money supply and cash in circulation has actually been falling. See James Hamilton’s (Professor of Economics at the University of California).
And as for buying gold:
“[The] view that gold will see a substantial re-valuation is correct but it may take a detour back to $400 or lower – simply because in the deflation to come, which will be brought on by an escalation of the current liquidity crisis, gold will be sold off to pay for margin calls. Gold will be re-valued in the future because it will most likely come back into service again as the standard against which all currencies will be measured. This accelerating crisis has been brought on by banks by-passing the prudential requirements through securitization of mortgages and by the use of massive leverage on the part of borrowers to magnify the gains made from the consequent asset inflation. Credit creation (money supply) has been on a tear for a decade or more because banks were able to keep the loans off their balance sheets through securitization. This process is now in the early stages of reversal.
“Most of what we read about in the financial columns today was brilliantly explained by Robert Prechter (of Elliottwave International) in his best seller of 2003 Conquer the Crash. As far as the equity markets are concerned, he was wrong in nominal terms because they continued to rise until last October. In terms of gold, the Dow, S&P500 and NASDAQ have all been falling since 1999. His explanation then of the likely unfolding of events is closer to what is happening right now than any other commentator present or past. Inflation is NOT the issue. The markets know it (why else would US bonds and Treasury notes be in such demand) and the Fed (as always) is following the 3 month US treasury bill down the lowering yield path. I believe that the US Treasury market is telling the real story.”
Dan Denning offers a rebuttal in today’s guest essay, below. Keep reading…
Markets and Money