When Bill Gross, the bond guru manager of Pimco Total Return Fund, says “it’s happening,” he brings credibility to the deflation first scenario, that is deflation before inflation. According to yesterday’s WSJ article many fund managers are loading up on US Government bonds and hedging stocks. Others expect the Fed to come to the rescue. The Fed has limited options since it has interest rates near zero. According to another WSJ report these options are “unorthodox!” As the Fed mulls these, it may spook investors and highlight the weakness in the economy. So when the Fed is playing offense in trying to reflate the economy, savvy investors might conclude as Gross did that it’s time to play defense. Typically these “unorthodox” measures mean increasing the money supply by buying bank assets good and bad, bonds and mortgage backed securities. Problem is that there are not too many bullets left in the Fed’s arsenal.
To cap matters off, vis a vis the “self fulfilling prophesy,” today’s WSJ leads the front page with “Fed Mulls Symbolic Shift” that is using cash from maturities to buy additional assets instead of letting its portfolio shrink to a stable economy level. The Fed’s $2.3 Trillion portfolio has nearly tripled in size since 2007!
So, what to do? If prices are going to be lower tomorrow, why buy today? And this, ad infinitum! Couple this with Hussein Obama’s proposed tax increases, the pile on of entitlement deficits from Obamacare, and the great uncertainty posed by the regulatory bureaucracy, and you get a bleak picture.
Hope I’m wrong!
#1 by Chuck Baird on August 3, 2010 - 6:59 pm
I am one economist who thinks that any deflation will be short lived. There is too much liquidity in the system. What holds inflation back, for now, is a decline in velocity due mainly to what Robert Higgs calls "regime uncertainty" — transactors simply do not know what to expect from our renegade government. If, in November, Republicans get control of at least one house of Congress, regime uncertainty will decrease and velocity will pick up.
#2 by renohayektjm2 on August 4, 2010 - 3:44 am
Thanks Chuck. You comment makes sense. Increasing velocity means deals are getting done, frozen markets are clearing, investments are being made, and eventually consumers consume more, save and de-leverage less. Using Tom's chess match impending rule change analogy of our last meeting, the rules become more certain and the game continues. My only hesitation is that the bureaucracy has been delegated an awful lot of rule making power which will remain unabated even with a change in one house of Congress. I would therefore suggest that 2012 is perhaps the better key date. Strategists, time your balance sheet management strategies! tjm