There are still a lot of people out there who didn’t absorb last year’s course on the credit cycle, particularly the chapter on inflation and deflation. To remedy this gap in your elementary economic education, before buying resource stocks or saying that any market will go to the moon on Fed-powered rockets, you are required to read this refresher by Mish Shedlock. An except is below:
…there are practical as well as real constraints on what the Fed can and will do. Nearly everyone ignores those constraints in their analysis.
Congress in theory and practice can give away money. Indeed, Congress even does that to a certain extent. Extensions to unemployment insurance, increases in food stamps, and cash for clunkers are prime examples.
However, those are a drop in the bucket compared to the total amount of credit that is blowing up. Take a look at the charts in Fiat World Mathematical Model if you need proof.
The key point is it is the difference between Fed printing and the destruction of credit that matters! As long as credit marked to market blows up faster than handouts and monetary printing increase we will be in deflation. Deflation will not last forever, but it can last a lot longer than most think.
Also ponder this missive from the dean of Deflation U, Robert Prechter:
“The Fed’s balance sheet ballooned from $900 billion just five months ago to more than $2 trillion, by buying outright, or swapping the pristine credit of U.S. Treasury debt for the questionable paper held by troubled banks, brokerages and insurance companies. One of the marketplace’s most strongly held beliefs is that the U.S. dollar is on the verge of an imminent collapse and gold is set to soar because of the Fed’s historic and irresponsible balance sheet expansion… We agree about the irresponsible part, but not about the near-term direction of the dollar and gold. Our forecast is being borne out by the dollar, which has soared straight through the Fed’s most aggressive expansion to date. Just as Conquer the Crash forecasted, the Fed is fighting deflation but, as the book says, ‘Deflation will win, at least initially.’ The reason is that there are way more debt dollars than cash dollars, with about $52 trillion currently in total market credit. As this enormous mountain of debt implodes, it is swamping all efforts to inflate. Of course, the Fed has explicitly stated that it will keep trying. Its initial effort was akin to trying to fill Lake Superior with a garden hose. But $2 trillion still won’t do the trick of stemming a contracting pool of $52 trillion. The only real effect is that taxpayers get hosed. Obviously not all of the $52 trillion is compromised debt, but the collateral underlying this mammoth pool of IOUs is decreasing in value, placing downward pricing pressure on the value of related debt, which won’t show up in the Federal Reserve figures for many months. A reduction in the aggregate value of dollar-denominated debt is deflation, which is now occurring. Eventually the value of credit will contract to a point where it can be sustained by new production. At that point, the U.S. dollar may indeed collapse, as gold soars under the weight of the Fed’s bailout machinations. But deflation must run its course first. In our opinion, it has a long way to go…”
Also consider an oldie from yours truly (Some Basic Points on Inflation and Deflation):
#1 The business cycle is the credit cycle.
#2 Inflation is a net increase in money and credit, not just prices (mainstream opinion) and not just money (common misconception among contrarians).
#3 Deflation is a net decrease in money and credit.
#4 There cannot be both inflation and deflation at once.
#5 The central bank and the government bring about inflation by absolving banks of the responsibility for their actions. 9:1 fractional reserve lending would not be rewarded in a free market devoid of FDIC insurance and a central bank to print the money to pay for it and other bailouts for bankers.
#6 Price increases themselves are not inflation. If you have a fixed expense budget and your grocery and energy bill goes from $500 to $700, you must cut back $200 somewhere else (for instance, many are deciding to forgo eating out).