Essentials ...
Q
Essentials You Need to Know.
A
Posted Feb 24, 2008.
ONE: The long term trend shifted from price disinflation to price inflation in 2003. That means tightening will only temporarily slow or reverse the increases of prices unless the Fed is willing to bankrupt a large portion of the economy. So far the Fed has run very tight policy since 2005 (which is why the housing market collapsed), but which is insufficient to fully reverse price pressures. The Fed determines the policy of inflation and deflation by (1) the necessity of providing a bond market for the Federal Government while (2) keeping the banking system afloat. Only when #1 is severely threatened would they risk #2 (1980s, 2007 ?).
TWO: The Fed provides a market for government bonds by oscillating policy. This has two effects (1) to push participants to one side of the market which leads to sudden and volatile collapses in markets, and (2) to boost the willingness to hold cash which can be depreciated later for a "bailout". That means there is cyclic risk for BOTH inflation and deflation, even when the underlying trend is favorable to a particular institution or individual. For those quick to benefit from recent price inflation, less cash might be kept to protect against monetary tightness. BUT for the majority of all other companies and individuals, credit disappearance (bond buyers go on strike) plus periodic tightenings will catch them "cash short" and force selling of assets that later will be more expensive or impossible to replace.
THREE: Unless an individual or company is confident of being advantaged by inflation, it is best to hold the best of BOTH inflation and deflation hedges. (Examples of both: Purchasing short term high quality corporate bonds of sound companies not at risk in inflation or deflation, gold, rental real estate bought on 50% borrowed money with long-term fixed rate renegotiable debt, commodities not bought with margin, energy stocks, etc). Watch gold as a leading indicator of inflation and deflation and be careful of relying on continuous credit access. Credit can vanish because of either deflation or inflation.
THE MILLION DOLLAR QUESTION: Where and how will the authorities make the next market in U.S. government bonds?
ONE: The long term trend shifted from price disinflation to price inflation in 2003. That means tightening will only temporarily slow or reverse the increases of prices unless the Fed is willing to bankrupt a large portion of the economy. So far the Fed has run very tight policy since 2005 (which is why the housing market collapsed), but which is insufficient to fully reverse price pressures. The Fed determines the policy of inflation and deflation by (1) the necessity of providing a bond market for the Federal Government while (2) keeping the banking system afloat. Only when #1 is severely threatened would they risk #2 (1980s, 2007 ?).
TWO: The Fed provides a market for government bonds by oscillating policy. This has two effects (1) to push participants to one side of the market which leads to sudden and volatile collapses in markets, and (2) to boost the willingness to hold cash which can be depreciated later for a "bailout". That means there is cyclic risk for BOTH inflation and deflation, even when the underlying trend is favorable to a particular institution or individual. For those quick to benefit from recent price inflation, less cash might be kept to protect against monetary tightness. BUT for the majority of all other companies and individuals, credit disappearance (bond buyers go on strike) plus periodic tightenings will catch them "cash short" and force selling of assets that later will be more expensive or impossible to replace.
THREE: Unless an individual or company is confident of being advantaged by inflation, it is best to hold the best of BOTH inflation and deflation hedges. (Examples of both: Purchasing short term high quality corporate bonds of sound companies not at risk in inflation or deflation, gold, rental real estate bought on 50% borrowed money with long-term fixed rate renegotiable debt, commodities not bought with margin, energy stocks, etc). Watch gold as a leading indicator of inflation and deflation and be careful of relying on continuous credit access. Credit can vanish because of either deflation or inflation.
THE MILLION DOLLAR QUESTION: Where and how will the authorities make the next market in U.S. government bonds?