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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: westpacific who wrote (49856)	1/16/2006 8:58:44 AM
From: glenn_a	Respond to of 110194

Hi West. ((The authorities have little control.....Glenn, please understand this.)) Gulp. I have to admit when I first read this I mentally kicked myself and thought "dam*ed, how could I fall for the fallacy that the Fed had some modicum of control in all this" ... and I want to give this some more thought. But just off the top, is it possible they have more control that it might seem. Bear with me here. What I feel the Fed does not have control over is ultimately avoiding a day of reckoning. What I do think they may have some control over is what that day of reckoning looks like ... but I may be wrong here. If I'm not mistaken, and I can review the history of it will help, the German economy did not suffer from serious deflation for most of the 1930's. Even though, in monetary terms, they were by far the most indebted nation at the outset of the 1930's. The reason? They negated all claims on the Deutchemark. Britain, another debtor nation at the outset of the 1930's, also did not suffer as badly from deflation, certainly not nearly as badly as the US. Great Britain benefited from a weak British Pound, and I believe by '33 or '34 their economy was relatively healthy (certainly compared to the U.S.). The major economy that suffered most in the Great Depression was the US. They had been the largest creditor nation at the time, and the rising industrial power (not unlike China today). Speculation had run rampant in financial assets, and a lot of credit had been extended, to Germany in particular, that was not to be repaid, as well as to farmers, stock speculators, etc. The US also had enormous excess industrial capacity, and the world's strongest currency. The US suffered severe deflation. One of the lessons of the 1930s, I believe, is that Capitalism involves a continuum of monetary (or more precisely credit) claims. These monetary claims provide incentives for the flow of goods and services in the real economy. If this system breaks, then the flow of goods and services need a new incentive system to allocate scarce resources. This is significantly the function of war. Deflation sets in to my mind when an economy has become severely indebted, and monetary authorities try to protect the value of outstanding monetary claims. But this is not the only option. ((When this deflation really kicks in, it will run its course, no one will have the power to control other than free markets.)) I guess that's the point, that letting the "free market" resolve the situation of massively inflated credit claims in the economy is not the only alternative. If authorities choose to protect the value of existing monetary unit, then I think yes. But again, their are other options. On this "other options" front, let's see what happens with Iran. The ability of the US to force payment for oil in US$ may be at stake here. I might be wrong in my thinking here. So I look forward to your reply. Best wishes, Glenn

To: westpacific who wrote (49856)	1/16/2006 9:54:17 AM
From: Mike Johnston	Respond to of 110194

The authorities have quite a bit of control in a system of quasi free market economy. They have control over which hedge funds or banks to bail out or not, how much of government debt to monetize or not, they have the power to monetize tax cuts, to devalue the currency, to manipulate statistics, to intervene in the markets etc. Printing money is far easier and more popular than raising taxes or cutting spending or allowing the population to be at the mercy of "evil" economic cycle. That is why we are where we are today: -declining standard of living -high inflation -house affordability at record lows -gutted manufacturing base -artificially stimulated consumption -huge budget and trade deficits -rising fraud and corruption -low savings rate -massive government, corporate and consumer debt -declining product and service quality -declining work ethic

To: westpacific who wrote (49856)	1/16/2006 2:59:14 PM
From: kris b	Read Replies (1) \| Respond to of 110194

When this deflation really kicks in, it will run its course, no one will have the power to control other than free markets" Right on. Even Japan with massive savings (20% of the disposable income is put away but Japanese every year) of the population couldn’t end the deflation for 15 years. They are the creditor nation to boot. US not only doesn't have any saving but and is biggest borrower in the world. You need willing borrowers and lenders to transmit the liquidity into the economy. In deflationary depression you have neither. Printing/creating credit by itself doesn’t do any good.

To: westpacific who wrote (49856)	1/17/2006 12:13:14 AM
From: SouthFloridaGuy	Respond to of 110194

I tend to agree with that line of reasoning as well. The Fed cannot create enough "liquidity" in the short or even intermediate term to compensate for rising risk-premiums should the default rate pick up significantly. In previous cycles, the Fed could cut 500-600+ basis points, steepen the yield curve, and encourage speculation and credit expansion. But speculation has been encouraged (many times over in the past 20 years) and when the next default cycle begins in earnest (2nd half of '06) the Fed will not be able to stop it quite as easily as in the past. Simply cutting to 1% ff will only mean 350bp of rate cuts, which pales compared to the brute force of the early 90's where they cut 650bp and the last cycle which saw 550 bp in a relatively short time frame. In addition, I peg real-inflation at about 2.5% right now. There is a camp that thinks inflation will spiral out of control and another camp which thinks we are heading for a deflationary outcome. I am in the latter camp which believes that the Fed will cut rates from an already low level only to be met with deflationary pressures. Whereas in the past 2 cycles, the Fed was able to create an environment of negative real interest rates, I do not think they will be able to do it so easily next time. By definition it cannot be done if inflation becomes deflation. In other words, overcapacity creates deflation which in turn negates the intent of liquidity. At that point the Fed becomes powerless to stop the economy's natural cleansing process.