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Thursday, March 28, 2024

Deflation is coming

Courtesy of ZeroHedge. View original post here.

Submitted by South of Wall Street.

Deflation is coming

www.southofwallstreet.com

In going thru old research I found a note from Dave Rosenberg in March of ’08, where he discusses Bernanke’s decisions on rate cuts and points to his speech from 2002 on deflation as a road map for his options.  At the time, cutting the Fed Funds rate was ‘the answer’ that rallied markets and substantiated the Fed’s ability to maintain confidence in financial markets.  We all know how that ended.

Rosenberg from 3/18/08 at ML:

We believe that Fed Chairman Bernanke is now fully in charge of the FOMC and he likely does not want to take a chance of disappointing the still very fragile financial markets. More importantly he understands that we are simultaneously facing a credit crisis, deepening housing market meltdown, and an unfolding economic recession.  (Sounds a lot like today, doesn’t it?)

He goes on to question what Bernanke can do if rate cuts don’t work:

Since the last rate cut, the Dow is down more than 500 points and

BBB corporate spreads have widened out an extra 50 basis points. Financial

conditions are actually tightening. So don’t think for a second that Bernanke does not have something up his sleeve – we think the press statement is going to be very key. What other aggressive action can the central bank possibly take?


Today Big Ben sits in a similar, but more nuclear situation.  In this 2002 speech he suggests the ability to buy foreign debt:

The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt

We aren’t far away from that being our last option, are we?  It will be a sad day if we start buying foreign wallpaper.  Here’s the point of my note – if you look at where we are today, markets are becoming more fragile – requiring more ‘solutions.’  At the end of the day bad debt can’t be subsidized by facilities or coordination.  Debt has to be destroyed, which will cause levered market participants to fail and ripples to spread.  Its not doom and gloom BS – its the only way capital markets become healthy again.  Think of it as a backed up drain that all the Drano (liquidity) in the world can’t unclog.  You’ve got to cut the bad pieces of the pipe out, which may cause you to tear up the whole bathroom – causing your wife (or husband.. or mistress)  to bitch and moan, but you eventually rebuild and move on to the next crisis.  That was pretty lame… sorry.

Bernanke continues in his address on why the Japanese couldn’t fight deflation:

The claim that deflation can be ended by sufficiently strong action has no doubt led you to wonder, if that is the case, why has Japan not ended its deflation? The Japanese situation is a complex one that I cannot fully discuss today. I will just make two brief, general points.

First, as you know, Japan’s economy faces some significant barriers to growth besides deflation, including massive financial problems in the banking and corporate sectors and a large overhang of government debt. Plausibly, private-sector financial problems have muted the effects of the monetary policies that have been tried in Japan, even as the heavy overhang of government debt has made Japanese policymakers more reluctant to use aggressive fiscal policies (for evidence see, for example, Posen, 1998). Fortunately, the U.S. economy does not share these problems, at least not to anything like the same degree, suggesting that anti-deflationary monetary and fiscal policies would be more potent here than they have been in Japan.
Well, it looks like things have changed from 2002, we aren’t much different now from where Japan was.  The US now has a large overhang of government debt and massive financial problems in the banking and corporate sectors muting the effects of monetary policies (ZERO HOUR). 

Deflation appears unavoidable.  I’m renting assets until we see the painful – but necessary bust to rectify imbalances in liabilities.  So, with today’s news about increasing liquidity via swap lines – I can’t help but sense that Central banks see something developing that guys who stare at blinking screens don’t.
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