Deflation, Inflation, Politics and Insanity Stewed to Perfection.

Abstract: Half the economists and most of the government leaders do not know what they are doing. They tempt fate with higher and higher debt ratios to their GDPs. Most are divided as to the answer to the essential question whether we are in deflation or heading for inflation. Their analytical tools are either rusty or their economic vision is blurred by politics. Whatever the theories or politics we are clearly entering some new arena of massive world debt.

We might presume, given the mountain of books and theories of economics, the queen of the social sciences[1], that some general consensus of how to handle government spending, unemployment and its concomitant debt and the effect on the value of currencies of the world might be readily found and shown, when appropriate, to political leaders and bankers in words of few syllables.  We might further presume that they would pay attention to the laws of economics, if they are known with any certainty[2], and adjust their policies accordingly. These presumptions are faulty at best. Those who ‘study’ the grand science of economics and finance can agree on little and much of this posturing appears to be based on the salient fact that they are thinking backward from their political indoctrinations thus their conclusions derived from objectively perusing the data and arriving at a sound conclusion are phony if not fraudulent.

They cannot decide if we are deflating or inflating at this point in the economic space-time continuum. This appears to be as comical as the hypothetical case where some new NFL team is created with pomp and circumstance, the stadium built and adorned, the cheerleaders selected by acclaim for their many desirable attributes and then the process is stalled for wondering why the ball is not round.

The quest for capital is essential to business and we may question the role of government and the now hollow zombie banks in their ability or desire to ‘make loans’ to business given the entanglements and interference from Congress.

Many, like Mr. Evans-Pritchard’s of the Telegraph believe, and have demonstrated quite convincingly, that we are in a downward debt-driven deflationary spiral.[3] Others like David Galland think we are heading for massive inflation and disagree.[4] This is not possible simultaneously, but deflation could transition to inflation very quickly.

At the expense of being accused of seeking a reasonable and unexpectedly valid source of information on this dilemma, we might look at the markets, relying on such obtuse capitalism notions as the once-sufficient law of supply and demand, for a quick view:

Surprisingly, the junk bonds have done well raising some 163 billions and “Junk bonds returned 31 percentage points more than the Standard & Poor’s 500 Index’s 26.5 percent in 2009.”[5]

So, junk bonds of the CCC [high risk rating] type are selling well and have good returns.

Paul Krugman guessed wrong on this one[6] and predicted a bubble, but recall that junk bonds have little or no government inference or oversight and thus offer a degree of freedom beyond the clutches of the Marxists and their lackeys. Krugman is a liberal political activist who only advocates taxation and bigger spending by bigger and bigger government without exception.[7] Rogoff thinks this form of finance might trigger an asset bubble due to the short terms on the bonds and the upward pressure on the assets.[8] It is interesting that our government is doing the same thing with its short term Treasury sales [30 day T-bills at zero %] and frantic attempts to make up for the lost fraction of the GDP this recession has brought.  Apparently, our government believes that if wealth is lost, as in the housing bubble and the credit contraction aftermath, with more to come, they can just print money and use that to subsidize lost home equity with the intent of reproviding ‘affordable housing’ for the poor so we can all be ‘equal.’[9] Didn’t this result in a housing asset bubble? Spending all of what we have and then borrowing from the future is the preferred way in California[10][11][12] and other near destitute states awash in debt and now mere beggars but groping for money in the same fashion.

Getting back to market thinking, Bill Gross of PIMCO now cautions us that the government’s ‘sugar daddy’ performance in buying 1.25 trillions in mortgage goodies must [or will]  halt and thus a vacuum may exist.[13] Maybe deadbeat homeowners can issue their own junk bonds. The leftists cannot force themselves to cope with the bond markets even after a few centuries of examination and fitful moaning.[14] Bonds are the major financing arm of governments and have been for 5 centuries. Gold is soaring for what reason?[15] CCC rated junk bonds return almost 9% now while AAA treasuries are still near zero coupon. The corporations could borrow from banks that get federal funds at zero % for 3-5 % or a smidgeon higher and are not doing so.  Why is this? They must pay 8-12% on junk issues. The reason is not clear, at least to me, as the banks may be hoarding cash and lending only to AA rated borrowers and that leaves out many if not most small businesses. If true, the smaller players in this game have no other options for raising capital other than selling their own equities or bonds. Markets usually open doors to the path of least resistance like water seeks the lowest possible level and big banks with government chains wrapped tightly around them may deliberately lock out the little guys. Tax breaks go to unions and just about everybody else except small business and this is probably by design. Government can control and steer big business as they did with GM, Citi, BoA[16], AIG and Chrysler employing their apparent Socialist-Neo-Fascist blend of governmental[17]mechanisms, but cannot do the same for lesser business entities. Scarce capital may be the result of lending institutions being forced to favor green projects otherwise known as EcoNazism.[18][19] California will, hopefully, show us the folly of this clever maneuver by crashing their economy and fulfilling my prediction to the greatest extent as Spain has apparently done and put breaks on this novel infatuation with debt. Thus there is a large supply of corporate bond sellers and numerous junk bond buyers all content with the process so far. This is called a market.

Thus, we wonder if we have missed any outer barrier warning markers in this quest for financial oblivion we are heading into based on debt.  An article in the Irish Times peruses the views and options of bonds, debt and gold and is highly authoritative and soberly inquisitive in my view.[20] Some think we are entering into the second phase of our second great depression.[21]

We need to revisit the 1937 theories again and ponder some of this:

The Deflation fundamentals from Irving Fisher:

“Following the stock market crash of 1929 and the ensuing Great Depression, Fisher developed a theory called debt-deflation. According to the debt deflation theory, a sequence of effects of the debt bubble bursting occurs:”[22]

1.     Debt liquidation and distress selling.

2.     Contraction of the money supply as bank loans are paid off.

3.     A fall in the level of asset prices.

4.     A still greater fall in the net worth of businesses, precipitating bankruptcies.

5.     A fall in profits.

6.     A reduction in output, in trade and in employment.

7.     Pessimism and loss of confidence.

8.     Hoarding of money.

9.     A fall in nominal interest rates and a rise in deflation adjusted interest rates

How many of these parameters do we now fulfill in the U.S. or world wide?  For me, I see [1-4] in full force by home owners and civilians with falling home prices and saving rates soaring and [5] being stabilized only by cost cutting measures leading to higher efficiency thus higher profits and thus higher unemployment thus amplifying [6] and I think many corporations are hoarding money as in [8] while selling junk bonds while we have the Fed offering AAA rated bonds (while this still lasts) at zero percent or slightly above. [7] is obvious.

Spain and Ireland, that are two of the PIGS [Portugal, Ireland, Spain and Greece], are selling 34 billons in bonds via banks.[23] Both of these two countries are line for exciting sovereign defaults as did Iceland.  Austria, Belgium, Poland are selling at junk rates too while Cyprus, Hungary and Slovenia are in the que.

So, instead of cutting jobs and spending and trending toward austerity, the PIGS and others are going to borrow their way out of debt like California. We may get some novel coaching in basic finance in the next few quarters along with some defaults and other disasters if this continues. But, half the ‘experts’ consent and offer praiseworthy acclaim for massing spending by government—a group dominated by Neo-Keynesians. Perhaps debt can be converted into profits somehow in some new process yet to be unveiled in its glory. We shall see.

rycK

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