"hubris goeth before the fall." if someone doesn't know what inflation is they should read your post.
If that's true, they are falling into the same trap that has led to hyperinflation elsewhere, aren't they? My guess would be that they would try to create enough additional money and credit to somehow get the economy to a positive bias, and then slowly remove it after rates are back to normal? It occurs to me that on the one side, the other central banks that ended up causing hyperinflation didn't intend to do so either, and on the other side, failure to get it back to a positive bias could lead to "lost decades" like Japan has gone through. Either is bad, very bad. Anyway... Right now, today, its definitely a heavily deflationary bias with people losing jobs everywhere and those lucky one keeping their jobs taking pay cuts, commodity prices at crash levels, and housing and other asset prices falling rapidly. If Obama's stimulus package goes through, it might help slow or stop the fall of asset prices, by creating more demand, but with the horrifying price tag of adding another 10% to an already insurmountable amount of debt. The other problem is that with the structural trade deficit, as much stimulus as they pour in will just as quickly pour back out to the people we buy those imports from, leaving us right back to deflation when they balk at buying more of our assets or lending it back to us.
Therein lies the rub. Right now they are -not- balking at buying our assets. The central banks of the world a la China and Japan have a hoard of dollars and are hoarding treasuries with those dollar outflows we send. If they stopped sending those dollars back to our assets, and just instead held the cash and exchanged it automatically for other currencies, our exchange rate would plummet. By definition, that would be very inflationary for prices and likely stimulate our export economy, particularly in areas where we have input prices under control. As a matter of political policy, I think asian exporters have been happy gaining the right to own America (cheaper than the military way) and artificially propping up their export sectors up til now. The deepness of this recession will test their resolve to hold our assets as they steadily lose their value. I guess in their minds, the political leverage of holding large amount of dollars outweighs the benefit of moving their economy to consumption versus export models. Its been talked about here -- killing the US export sectors via artificially weak exchange rates, dumping, etc. may be an effective long term strategy. First they castrate our supply and ability to create supply (manufacturing and natural evolution of our comparative advantage), then they castrate our buying power. Furthermore, a declining exchange rate would create a situation where the public anticipated inflation continuing, thus stimulating investment rather than cash hoarding. Right now already, as evidenced by the gigantic spreads between mortgage agencies and treasuries, foreigners are already net sellers of agencies for the trailing 12 months. All of the TICs reports point to large spreads between treasuries and everything else being merely a result of all money going to treasuries versus everything else. With that in mind, outside of money printing preasure, I don't see as other sectors (ie municipal bonds and agencies) being such a great buy absent a treasury spread trade since what we've seen so far is merely a diversion of money flows, competition between available investment capital with treasuries winning. For the spreads to revert, treasuries will likely just have to fall (in price), and other asset classes remain in the same place... All points to a great treasuries short regardless (as a long term fundamental trade). I think 3 months from now, when fiscal stimulus is starting, and the Fed has already shown their hand with treasury/agency buying and money printing, is probably is the best time to take the trade. Too many programs to start in 09 that will continue injecting money. The fed is always behind ... they need inflationary pressures to react to before they mop up. They won't risk soaking up moving dollars unless they see a clear signal (prices already through the roof). Otherwise, all of they risk all of their efforts being in vain.
I dunno. I had all sorts of newsletters and advisors saying to short the bonds a few weeks ago, and they've really gotten creamed by 20% so far. If the Fed could push the rates down then, they could keep doing it, easily, perhaps without even trying if the market overall goes into another panic. I don't think there is much upside to the trade short term, because I don't see them pumping in enough to reflate, which probably also will get them accused of causing hyperinflation, but if you are thinking in terms of holding it till 2012 or 2013, I'd think its a good bet by then that the rates rise or the dollar collapses.
Words to live by! It's one thing to have an opinion - it's quite another to stake one's entire livelihood on said opinion. Bet like you could be wrong...
Hey scriabinop23, Merry Christmas. Sorry I never got back to you on the Austrian Thread. Will do so shortly. Glad to see you've woken up to another lie. "Deflationary Spiral" is nothing more than baseless, economic fear mongering designed to legitimize the cornerstone principle of fractional reserve banking - INFLATION!! How convenient for the Bankers who get to print money from nothing??? The analogy here is Osama Bin Laden, Emanual Goldstein or Saddams WMD's. Consider the Great Depression. The FED pulled gold deposits from banks across the country to choke money supply. In doing so, they deliberately and with full knowledge and foresight kept rates SKY HIGH for nearly a DECADE. Even despite the wicked and horrendous deflationary crash of the 30's, the economy COMPLETELY RECOVERED after credit was directly injected to finance war spending. Thats a great lesson in how little power "spiraling deflation" has when credit is restored and taps turn back on. The Banks are hoarding right now. This is akin to the setup to the Great Depression. Until Banks lend again, deflation continues.
I doubt the likelihood of a deflationary spiral because after all the monetary ease and coming fiscal stimulus takes effect next year, it will be too difficult for the Fed to "mop up" the excess liquidity. It took a "Reagan/Volcker" combo to take away the punchbowl in the early '80s......don't see that happening. I know the situation was different, but they had to resist a lot of screaming. Stosh