Deflation is the Master of the Field, Sweeping Away Inflation

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Inflation delenda est. Viva deflation!

And now Congress has passed a bailout bill…the fix is in…everyone will be protected…spared…saved. Inflation is going away. Prosperity is just around the corner. Hallelujah!

But wait…

Where’s the catch? There’s a crack in every bell God ever made…a little hairline fracture. Perhaps invisible to the human eye. Perhaps unnoticeable for many years. But hit the thing hard enough…and it falls to pieces. We’ll come back to this in a moment… First, let’s reminisce.

The last two weeks have been exhilarating.

What a joy it is to see the loopy humbugs of the financial world finally destroyed. The Efficient Market Hypothesis…Wall Street’s claim that it added value by “allocating capital efficient”…mergers, acquisitions, private equity…investment banking…the eternal bull market in housing…MBSs, CDOs, SIVs… almost every mention of these things today is accompanied by a knowing laugh.

And now we have a whole new bunch of loopy humbugs to take their places.

Now we have bailouts and recapitalizations…new restrictions, new villains…and ‘taxpayer funded’ rescues…

Half the countries of the world seem to have banned short selling – at least the half that knows what short selling is.

Archbishop John Sentamu, of York, said that short sellers were nothing more than “bank robbers and asset strippers.” It’s no wonder the Church of England is losing market share. It’s run by people who can’t tell a short seller from a bank robber. A bank robber steals money that isn’t his…and if he gets caught, he goes to prison. The short seller merely SELLS something that isn’t his. If he gets caught out, he goes to the poor house. If they still had poor houses.

Over the weekend, Germany became the latest government to ban losing money. Angela Merkel told the huns that their money was secure in German banks:

“We want to tell people that their savings are safe,” said she.

“I was out in LA when IndyMac went under,” said a friend over the weekend. “Of course, the FDIC guaranteed deposits up to $100,000. But I remember people standing in line for days to get their money. And there were fistfights in the line. When a bank goes down, it’s not pretty.”

No, it is not a pretty sight. It was the photo of people lined up in front of Northern Rock that caused the government to step in to protect depositors in Britain. And now, nervous depositors all over the world are causing governments to react…and over-react.

This morning, according to the Financial Times, Britain is considering some ‘drastic measures,” to recapitalize its banking sector.

“Iceland in talks to prevent meltdown,” is another headline this morning.

“Massachussetts may seek a US loan,” says the Boston Globe. Why not? The door’s open.

LA faces a $400 million budget deficit, says the local press.

And California itself is only two weeks away from being unable to pay teachers and firefighters, says the FT. The Golden State, unlike a sovereign country, has little room to maneuver. Although it is the world’s 6th largest economy, California can’t print its own money. Too bad. Printing money has been a great refuge of scoundrels since the printing press was first invented. Inflation erases debts and it lowers obligations. In a real inflationary surge, even things that are supposed to be “adjusted to the CPI” prove to be a great boon to the government and a great bust to people who depend on them.

Inflationary adjustment mechanisms aren’t able to keep up. In Zimbabwe for example, inflation is running at 200,000%. By the time a Social Security check or indexed bond is adjusted for the previous quarter’s inflation, it’s worthless.

Without the ability to print your own money, you have to live within your means – and that means…you can spend no more than you can beg, borrow or steal. And that is what has so many people so desperately afraid. Borrowing is out; the banks aren’t lending. Stealing is still big business, but the feds have a near-monopoly on it. Jobs are disappearing, too. The latest jobs reports shows rising unemployment. That leaves only begging – so get out the bowl.

*** “Glut of retail failures forecast,” says the Financial Times. Every businessman we know is cutting back…trimming…saving…trying to protect his business. And consumers too are beginning to grow more cautious.

“Consumers Tighten Belts,” says the New York Times. Airline travel is collapsing.

Economic activity is collapsing in Europe; in Britain, reports the Wall Street Journal, private output is falling faster than it ever has since they began keeping records.

*** Stocks tumbled at the open this morning, with the Dow falling below the 10,000 mark for the first time in almost four years. Across the globe, the picture wasn’t much better…in Japan, the Nikkei fell to a four-year low, and in Europe, governments rushed to prop up failing banks.

A new report released by the Group of 30 (G30), which consists of top economists and financial experts, found that – gasp! – there is a lack of appropriate and necessary banking regulation, not just in the United States, but worldwide. We wonder what tipped them off?

“There is great unanimity in the feeling that regulation and supervision need to be revised,” said Paul Volcker, chairman of the board of trustees for the G30, at a press conference. “The current situation is an apt illustration of the need for reform.”

The former Fed Chairman is the first person to come to mind when looking for perspective on financial disasters – after all, he presided over one of the gloomiest periods in American economic history in the late ’70s and early ’80s.

Addison and Short Fuse went to Volcker’s office in New York City last winter to interview him for I.O.U.S.A. They asked him questions about his epic battle with inflation as Fed Chairman, and naturally, the conversation came around the current financial difficulties the Unites States faces.

“With respect to the fiscal crisis looming out there in the future,” says Paul Volcker, “We’ll see whether a democracy can deal with an obvious problem that’s going to be present in not too many years. The earlier we take action to deal with it the better.”

But as usual, U.S. officials waited until the last minute to act. Nothing new there.

And keeping with I.O.U.S.A. news, Addison and David Walker will be speaking to the National Press Club on this coming Wednesday, October 8. Short Fuse will have a full report on Thursday. Stay tuned…

*** “This is the real deal,” says colleague Chris Mayer, in reference to the credit crisis.

“This is severe. And I think it is possible good companies could go down as the credit markets lock up.

“Just the other day, the Financial Times reports: ‘A virtual funding freeze… has affected even top-rated companies such as General Electric… and AT&T.’ It’s a dangerous time. The fear out there is extreme. That explains why the yield on one-month Treasury bills fell to zero at one point during the recent panic. Investors just wanted safety. They didn’t care about yield. They wanted a place to put their money where they can be sure they will get it back.

“Hence, the rush to Treasury securities. On the last day of the quarter, the 10-year note hit 3.83%. If you bought the 30-year T-bond a year ago – which most people thought was a dumb bet – you would have netted a 16% return one year later, as rates fell and your bond price rose. Not bad, huh?

“This rush for safety is also rallying the U.S. dollar. Despite all its flaws and all that it’s been through, when people are scared, they want the old greenback. Cash. Commodities, meanwhile, have sold off something fierce.

“Until the wave of bank failures and credit scares dies down, I don’t think we’ll see these trends reverse anytime really soon. What we have is a sharp countertrend in a long-term inflationary and commodity bull market.”

*** But let us go back and put this is a wider perspective. The U.S. stock market peaked out in January 2000. Normally, a bear market and credit contraction would have followed. Instead, the feds gave the world the biggest dose of credit in history. This new credit goosed up the real estate market so that practically everyone thought he was getting rich… Spending increased. Savings disappeared. The stock market rebounded…and passed, at least in nominal terms, its 2000 high.

Money flowed like hot oil, greasing transactions all over the world. It made the world economy run hot. And pretty soon, prices were rising sharply. The Chinese needed more oil, more palladium, more copper! Oil went over $140 a barrel. Gold rose over $1,000.

Energy became so valuable that food crops were diverted to making more of it – especially in North America. Then, the price of food shot up too.

For a while, the battled between inflation and deflation raged – with no clear winner. Housing prices were already going down. A few ‘early bird’ companies were already singing the blues. But prices were still soaring.

“Stagflation,” yelled the economists.

But as the quantity of new credits expanded, naturally, the quality of them decreased. Speculators earned huge fees by borrowing low…and lending wildly. The hot grease led to such slippery transactions – soon, the whole world economy was in a slide.

“I remember when I bought a house for the first time about 20 years ago,” continued our friend. “The mortgage loan got held up because I had a late payment for $36.72 – I can’t remember what it was for – on my credit record. They wanted to know why the payment was late. Of course, it has been years before and I had no recollection of it. I eventually got the loan, but it wasn’t easy.

“Then, when my daughter bought a house about 3 years ago, they didn’t ask any questions at all. All they wanted to know was whether she had a pulse.”

As you might expect, when you lend recklessly a lot of your loans are going to go bad. In the event, a whole category of mortgage loans – subprime – blew up. And then a strange, foul odor began coming up financial institutions all over the world. It was the smell of rotten debt – subprime, Alt-A…commercial finance of all sorts.

With the stink of decaying assets in their nostrils, bankers and speculators had no option; they had to run for cover…and then the exits were jamming up everywhere.

But don’t worry. “It’s contained,” said the Secretary of the Treasury. We’ll deal with it, said the Fed Chief. But the panic grew. People lined up in front of banks. Then, in the space of just a few weeks, virtually the entire investment banking industry ceased to exist.

“What do you say to the poor investment banker who just lost his job?” our friend asked. Then, answering his own question: “I’ll have a burger with fries. Hold the mayo.”

And now deflation is master of the field. It has swept away inflation. Prices are falling almost everywhere. Oil is back under $93 this morning. Gold is $840.

Viva deflation!

But wait…the feds aren’t going into that good night without a fight. That’s what this $700 bailout bill is all about. Put more money into the system! Buy ‘distressed’ assets! Save the banks!

But wait…there’s more. The bailout bill includes a provision raising the amount of bank deposits guaranteed by the FDIC. Until now, you could only have $100,000 in a bank and be sure the feds were covering it. Now, the amount is $250,000.

Good move, right? Everyone thinks so. It will stop a run on the banks, they say.

Again, it may be a good move in practice. What bothers us is the theory of it. Where do the feds get the money to cover such a big bailout? They now guarantee more than $5 trillion in bank deposits, according to our source. Does the FDIC have $5 trillion lying in a vault somewhere?

Of course not. But if the feds guarantee deposits, no one needs to take his money out…and the feds never need to put up any money, right? What a delight! The feds can insure $5 trillion in deposits and it doesn’t cost a penny!

Win…win…win…LOSE! Ah…there’s that crack in the bell…that little detour on the way to perfection!

Until tomorrow,

Bill Bonner
The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
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bloodworthy
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It’s OK Bill, its just a bad dream, you’ll wake up in the morning and it will all be OK…..

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