Saturday, October 4, 2014

05/22/2009 Inflationism's Seductive Battle Cry *

For the week, the S&P500 gained 0.5% (down 1.8% y-t-d), and the Dow added 0.1% (down 5.7%). The Morgan Stanley Consumer index rose 1.6% (up 0.1%), while the Utilities dipped 0.3% (down 12.7%). The Morgan Stanley Cyclicals rallied 2.5% (up 11.0%), while the Transports fell 1.5% (down 15.0%). The volatile Banks declined 2.6% (down 19.5%), while the Broker/Dealers gained 4.2% (up 23.4%). The broader market ended the week somewhat higher. The S&P 400 Mid-Caps gained 1.0% (up 2.4%) and the small cap Russell 2000 added 0.4% (down 4.4%). The Nasdaq100 gained 0.6% (up 12.5%), and the Morgan Stanley High Tech index advanced 1.7% (up 22.0%). The Semiconductors jumped 3.4% (up 18.0%), and the InteractiveWeek Internet index gained 1.5% (up 32.4%). The Biotechs rallied 0.7% (down 4.2%). With Bullion jumping $26, the HUI gold index surged 10.9% (up 25.4%).

One-month Treasury bill rates ended the week at 13 bps, and three-month bills closed at 19 bps. Two-year government yields rose 4 bps to 0.85%. Five year T-note yields jumped 21 bps to 2.19%. Ten-year yields surged a notable 31 bps to 3.45%. The long-bond saw yields rise 30 bps to 4.38%. The implied yield on 3-month December ’09 Eurodollars was unchanged at 0.95%. Benchmark Fannie MBS yields rose 19 bps to 4.15%. The spread between benchmark MBS and 10-year T-notes narrowed 12 bps to a skimpy 69 bps. Agency 10-yr debt spreads narrowed one to 37 bps. The 2-year dollar swap spread declined 1.5 to 40.3 bps; the 10-year dollar swap spread increased 5.4 to 14.4 bps; and the 30-year swap spread increased 11 to negative 30.4 bps. Corporate bond spreads were mostly tighter. An index of investment grade bond spreads narrowed 11 to 197 bps, and an index of junk spreads tightened 20 to 930 bps.

May 18 – Bloomberg (Lukanyo Mnyanda and Anna Rascouet): “European bonds are beating Treasuries for the first time in four years… While the Fed is spending $300 billion buying Treasuries, part of $12.8 trillion committed by the U.S. to lift the country out of its deepest recession since the 1930s, the ECB has committed to buy 60 billion euros ($81 billion) in covered bonds, securities backed by mortgages and public-sector loans.”

The corporate debt issuance boom runs unabated. Investment grade issuers included ConocoPhilips $5.25bn, Verizon Wireless $4.0bn, Hewlett-Packard $2.0bn, Berkshire Hathaway $1.0bn, Aflac $850 million, Principal Financial $750 million, Kellogg $750 million, State Street $500 million, Praxair $500 million, Nordstrom $400 million, PPL Electric Utilities $300 million, Beckman Coulter $500 million, Gulfstream Natural Gas $300 million, Panhandle Eastern Pipeline $150 million, and Central Maine Power $150 million.

The strongest week of issuance in in two years put three-week junk issuance at a record $9.8bn (from Bloomberg). Junk bond funds saw inflows of $306 million this past week (from AMG). Junk issuers included Warner Music Group $1.1bn, Power Sector Assets $1.0bn, Apria Healthcare $700 million, Ashland Inc $650 million, Ameristar Casino $650 million, Gibson Energy $560 million, Corrections Corp $465 million, Berry Petroleum $325 million, Bio-Rad Labs $300 million, Scientific Games $225 million, Cellu Tissue $255 million, Markwest Energy $150 million, Hughes Network Systems $150 million and Compass Energy $100 million.

Convert issuance this week included Anglogold $730 million.

International dollar debt issuers included Barclays Bank $2.0bn, Westpac Securities $1.5bn, South Africa $1.5bn, Atlantic Finance $1.25bn, UPC Holding $400 million and Banco Bilbao $200 million.

May 22 – Bloomberg (Patricia Lui and Garfield Reynolds): “Emerging-market equity funds, led by China, Brazil, India and Taiwan, attracted most of the cash that investors have been pulling from money-market funds… EPFR Global said. The funds lured a total of $21 billion in the past 11 weeks… while Europe, Japan and U.S. saw combined outflows of $14.1 billion…”

U.K. 10-year gilt yields jumped 19 bps to 3.72%, and German bund yields rose 18 bps to 3.54%. The German DAX equities index jumped 3.8% (up 2.3%). Japanese 10-year "JGB" yields rose slightly to 1.43%. The Nikkei 225 slipped 0.4% (up 4.1%). Emerging markets were solid. Brazil’s benchmark dollar bond yields rose a modest 4 bps to 6.04%. Brazil’s Bovespa equities index rallied 3.2% (up 34.7% y-t-d). The Mexican Bolsa gained 3.2% (up 7.7% y-t-d). Mexico’s 10-year $ yields were little changed at 5.94%. Russia’s RTS equities index surged 9.0% (up 61.5%). India’s Sensex equities index jumped 14.1% (up 43.9%). China’s Shanghai Exchange declined 1.8% (up 42.7%).

Freddie Mac 30-year fixed mortgage rates dipped 2 bps to 4.82% (down 116bps y-o-y). Fifteen-year fixed rates declined 2 bps to 4.50% (down 105bps y-o-y). One-year ARMs jumped 11 bps to 4.82% (down 4bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down a notable 15 bps to 6.22% (down 83bps y-o-y).

Federal Reserve Credit inflated $48.6bn last week to $2.165TN. Fed Credit has declined $81.4 y-t-d, although it expanded $1.294 TN over the past 52 weeks (149%). Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 5/20) surged $25.9bn to a record $2.710 TN. "Custody holdings" have been expanding at an 20.0% rate y-t-d, and were up $433bn over the past year, or 19.0%.

Bank Credit dropped $34.4bn to $9.754 TN (week of 5/13). Bank Credit was up $336bn year-over-year, or 3.6%. Bank Credit was down $159bn y-t-d (4.4% annualized). For the week, Securities Credit gained $6.1bn. Loans & Leases sank $40.6bn to $7.079 TN (52-wk gain of $183bn, or 2.6%). C&I loans declined $9.0bn, with one-year growth of 0.8%. Real Estate loans dropped $24bn (up 6.6% y-o-y). Consumer loans fell $8.4bn, while Securities loans were little changed. Other loans added $0.6bn.

M2 (narrow) "money" supply increased $8.9bn to $8.313 TN (week of 5/11). Narrow "money" has expanded at a 3.9% rate y-t-d and 9.0% over the past year. For the week, Currency added $0.4bn, while Demand & Checkable Deposits dropped $15.3bn. Savings Deposits surged $39.1bn, while Small Denominated Deposits declined $5.2bn. Retail Money Funds fell $10.1bn.

Total Money Market Fund assets (from Invest Co Inst) dropped $16bn to $3.774 TN. Money fund assets have declined $56.7bn y-t-d, or 3.9% annualized. Money funds have expanded $265bn, or 7.5% over the past year.

Total Commercial Paper outstanding fell $14.1bn this past week to $1.284 TN. CP has declined $397bn y-t-d (61% annualized) and $471bn over the past year (26.8%). Asset-backed CP sank $25.8bn to $574bn, with a 52-wk drop of $170bn (22.8%).

International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were down $99bn y-o-y to $6.700 TN. Reserves have declined $245bn over the past 36 weeks.

Global Credit Market Dislocation Watch:

May 21 – Bloomberg (Andrew Frye): “U.S. life insurers, a group led by MetLife Inc. and Prudential Financial Inc., face ‘pain’ on more than $300 billion invested in mortgages tied to commercial property and multifamily homes, S&P said. ‘As the recession rolls on, we believe that there is an increasing possibility of distress for commercial real estate owners and for those that hold their mortgages,’ said S&P…”

May 20 – Bloomberg (David Mildenberg): “Bank of America Corp., the biggest U.S. bank by assets, raised about $13.5 billion by selling stock after U.S. regulators determined it needed more cash to weather an extended recession. Bank of America issued 1.25 billion shares at an average price of $10.77 each…”

May 21 – Wall Street Journal (Dan Fitzpatrick): “All 10 stress-tested banks ordered to raise capital by the federal government are well on their way to plugging their combined $75 billion capital hole, as investors such as hedge-fund manager John Paulson snap up a fast-growing supply of new shares. The Treasury Department's move to inject more than $7 billion into GMAC LLC pushed the total amount of capital raised or being sought through stock and asset sales… to $57 billion.”

Government Finance Bubble Watch:

May 21 – Wall Street Journal (Brian Blackstone): “Federal Reserve officials are open to raising the amount of Treasury and mortgage-related securities they are purchasing beyond the $1.75 trillion already committed… ‘Some members noted that a further increase in the total amount of purchases might well be warranted at some point to spur a more rapid pace of recovery,’ according to the minutes. The central bank has previously said it would buy as much as $1.45 trillion of mortgage-related securities, as well as $300 billion in longer-term Treasury securities.”

May 21 – Wall Street Journal (Darrell A. Hughes and John D. McKinnon): “The federal agency that backstops corporate pension plans reported that its deficit tripled in the last six months, to $33.5 billion.”

May 18 – Bloomberg (Joe Mysak): “The National League of Cities says it will ask the U.S. Treasury today for a $5 billion interest-free loan to capitalize a new municipal bond insurer it plans to create.”

May 20 – Bloomberg (Michael McDonald): “The Federal Reserve will tell a congressional committee today that it is reluctant to extend guarantees to California and other municipal market borrowers struggling to sell bonds. The House Financial Services Committee, chaired by Massachusetts Democrat Barney Frank, is conducting hearings on four municipal finance bills, including one that would give the Fed authority to guarantee the repayment of variable-rate bonds and short-term notes. Another measure would create a public finance office in the Treasury Department to reinsure $50 billion of municipal bonds through 2015.”

May 21 – Bloomberg (Brian Swint): “Britain had an 8.5 billion-pound ($13.4 billion) budget deficit in April, the most for the month since records began in 1993, and Standard & Poor’s… signaled the country may lose its top credit rating… Tax revenue fell 9.5% and spending increased 5.4%.”

May 18 – Bloomberg (Zoltan Simon): “The International Monetary Fund and the European Union approved Hungary’s plan for a wider budget deficit this year, limiting the need for spending cuts. The government now targets a shortfall of 3.9% of gross domestic product, compared with an earlier 2.9% plan…”

Currency Watch:

May 18 – Bloomberg (Kevin Hamlin): “China is stockpiling commodities such as copper and iron ore as part of a reallocation of its sovereign wealth amid concern that the value of its dollar assets may decline, according to the Royal Bank of Canada. ‘It’s part of an overall desire to decrease its exposure to dollar assets,’ said Brian Jackson, senior strategist at Royal Bank of Canada… China fears the hundreds of billions of dollars the U.S. is spending on bank bailouts and stimulus will cause ‘higher inflation and a weaker dollar,’ he said.”

The dollar index was hit for 3.6% this week to 80.05 (down 1.6% y-t-d). For the week on the upside, the Swedish krona increased 6.2%, the New Zealand dollar 6.1%, the South African rand 5.2%, the Canadian dollar 5.2%, the British pound 4.8%, the Australian dollar 4.6%, the Brazilian real 4.3%, the Euro 3.7%, the Swiss franc 3.3%, and the Japanese yen 0.4%. On the downside, the dollar gained about 1% on the Iceland krona and 0.2% on the Argentine peso.

Commodities Watch:

May 22 – Bloomberg (William Bi): “China, the world’s biggest metals consumer, increased imports of copper and aluminum to a record in April as buyers replenished stockpiles needed for the country’s 4 trillion yuan ($586 billion) stimulus program.”

Gold ended the week up 2.7% to $957 (up 8.5% y-t-d). Silver was up 4.9% to $14.70 (up 30% y-t-d). July Crude jumped $4.55 to $61.55 (up 38% y-t-d). June Gasoline surged 8.7% (up 72% y-t-d), while June Natural Gas sank 14.4% (down 38% y-t-d). Copper jumped 3.9% (up 49% y-t-d). July Wheat rallied 6.1% (up 0.3% y-t-d), and July Corn gained 3.1% (up 5.7% y-t-d). The CRB index advanced 3.3% (up 6.3% y-t-d). The Goldman Sachs Commodities Index (GSCI) surged 5.1% (up 20.4% y-t-d).

China Reflation Watch:

May 21 – Bloomberg (John Liu): “Fitch Ratings said it’s growing ‘increasingly wary’ of China’s banking industry and predicted the combination of record lending and falling corporate profits may cause bad-loan costs to swell. ‘At the heart of these concerns is the recent steep rise in corporate exposure amid concurrent decline in enterprise profits,’ Fitch analysts led by Charlene Chu said…”

Japan Watch:

May 20 – Bloomberg (Jason Clenfield): “Japan’s economy shrank by a record last quarter as exports collapsed and consumers and businesses slashed spending, a decline that probably marked the low point in the country’s worst recession since World War II. Gross domestic product fell an annualized 15.2% in the three months ended March 31…”

May 21 – Bloomberg (Jason Clenfield): “Japanese workers at the country’s biggest companies will have their summer bonuses cut by a record 19.4% this year, according to a survey… by the nation’s largest business group. Payments will fall about 94,250 yen ($1,000) to 754,000 yen, the steepest reduction since business-lobby Keidanren started to compile comparable figures in 1959. Summer bonuses are typically paid in June or July and represent about 10% of a fulltime worker’s annual compensation.”

May 18 – Bloomberg (Toru Fujioka): “Japan’s consumer sentiment rose to a 10-month high in April, adding to signs that the recession in the world’s second-largest economy may be easing.”

India Watch:

May 18 – Bloomberg (Pooja Thakur): “India’s benchmark stock index jumped a record 17%, bonds rose and the rupee gained the most in two decades after Prime Minister Manmohan Singh’s Congress Party won nationwide elections.”

Asia Bubble Watch:

May 21 – Bloomberg (Shelley Smith): “Asian corporate bonds recovered their losses since the collapse of Lehman Brothers Holdings Inc. as declining volatility and risk aversion lured ‘hot money’ to the continent, according to Calyon… ‘There’s a lot of hot money pouring into Asia,’ said Brayan Lai, a credit analyst at Calyon… ‘When risk aversion and volatility go down, people flock to assets in the region.”

May 21 – Bloomberg (Janet Ong and Chinmei Sung): “Taiwan’s economy shrank an unprecedented 10.24% last quarter as exports fell and businesses cut spending… The drop follows the fourth quarter’s revised 8.61% contraction…”

Latin America Watch:

May 18 – Bloomberg (Joshua Goodman): “Brazil is managing the financial crisis ‘extremely well’ and emerging as an engine of global growth, said Mohamed El-Erian… of Pacific Investment Management Co. ‘People certainly feel the crisis is a major stress test for Brazil and that they’ve done extremely well so far,’ El- Erian said… ‘People are starting to take Brazil very seriously, not just as a stand-alone country, but for the impact it can have on the global economy as a whole.’”

May 21 – Wall Street Journal (David Huhnow and Anthony Harrup): “Mexico’s economy shrank 5.9% in the first quarter from the fourth quarter of last year… its steepest decline since the depths of the country's 1995 peso crisis. That translates to an annualized quarter-on-quarter drop of 21.5%.”

Unbalanced Global Economy Watch:

May 20 – Bloomberg (Lukanyo Mnyanda): “Britain may lose its top-level credit rating at Standard & Poor’s for the first time as the government’s finances deteriorate amid the worst recession since World War II. The outlook was lowered to ‘negative’ from ‘stable’ because of the nation’s increasing ‘debt burden,’ S&P said… Britain would become the fifth western European Union nation to lose its rating because of the economic slump, following Ireland, Greece, Portugal and Spain. The U.K. plans to sell a record 220 billion pounds ($343 billion) of bonds in the fiscal year through March 2010…”

May 18 – Bloomberg (Alexis Xydias): “The 220 billion pound ($334 billion) hole in U.K. corporate pensions may push companies to cut dividends, damping the recovery in Europe’s largest stock market.”

May 21 – Bloomberg (Colm Heatley): “Irish mortgage lending fell 68% in the first quarter from a year earlier… The value of lending fell to 2 billion euros ($2.76bn) in the three months through March from 6.27 billion euros a year earlier… The volume of home loans dropped 61%...”

California Watch:

May 21 – Bloomberg (Michael B. Marois and William Selway): “California’s budget deficit may reach $24 billion next year as the worst recession in more than a half century depresses tax revenue, the Legislature’s budget analyst said. The state’s Legislative Analyst Office said revenue is likely to decline by $3 billion more than the $21 billion deficit already estimated by Governor Arnold Schwarzenegger’s budget office.”

May 21 – Bloomberg (Dan Levy): “San Francisco Bay Area home prices fell 41% in April from a year earlier as foreclosures accounted for almost half of all sales, MDA DataQuick said. The median price dropped to $304,000 from $518,000 a year earlier. That’s 54% below the peak reached two years ago…”

Muni Watch:

May 18 – Dow Jones (Lavonne Kuykendall): “Bond insurers, already battered by housing-market losses, could be facing a new storm: growing losses in their supposedly safe public finance business covering payments on tax-exempt debt. In California, where voters this week defeated budget proposals to cover a $21 billion budget gap, Moody’s… warned that if the state’s cash-flow borrowing needs rise to that level, ‘that may raise questions about the state’s longer-term credit profile.’”

Speculator Watch:

May 22 – Bloomberg (Linda Shen and Jonathan Keehner): “WL Ross & Co., Blackstone Group LP and Carlyle Group’s purchase of BankUnited Financial Corp., the largest U.S. bank to collapse this year, came with a signal from regulators that they may be willing to let more buyout firms snap up banks as failures soar to a 15-year high… The FDIC deposit fund is down 64% from its peak at the start of the second quarter last year, reflecting the shutdown of 22 lenders from April through December.”

Crude Liquidity Watch:

May 21 – Financial Times (Robin Wigglesworth and Andrew England): “The United Arab Emirates yesterday withdrew from plans to join a Gulf monetary union after objecting to a decision to locate the central bank in Saudi Arabia, dealing a potentially fatal blow to the project. A rift between the Arab world's two largest economies emerged earlier this month when the member states of the Gulf Co-operation Council (GCC) decided that Riyadh should host the body's central bank, rather than the UAE, which had requested being the bank's base as far back as 2004. ‘This is a matter of principle,’ a UAE official told the Financial Times. "This move will definitely weaken the proposed currency union, as you're taking out a third of the GCC economy."

Inflationism’s Seductive Battle Cry:

May 22 – Bloomberg (Dakin Campbell and Mark Crumpton): “Bill Gross, the co-chief investment officer of Pimco… said the U.S. ‘eventually’ will lose its AAA rating, but not any time soon. Both the U.K. and the U.S. have prospective deficits of 10% annually as far as the eye can see… At some point over the next several years’ the debt of each ‘may approach 100% of GDP, which is a level at which country downgrades tend to occur,’ he said… Gross’s comments today come two months after he said the U.S. government will need to spend as much as $4 trillion in additional capital to cushion a slowing economy. The Federal Reserve said March 19 that it would purchase $1.8 trillion in Treasuries and housing-related debt to lower borrowing costs. ‘We need more than that,’ Gross said at the time. The Fed’s balance sheet ‘will probably have to grow to about $5 trillion or $6 trillion,’ he said.”

May 19 – Bloomberg (Rich Miller): “What the U.S. economy may need is a dose of good old-fashioned inflation. So say economists including Gregory Mankiw, former White House adviser, and Kenneth Rogoff, who was chief economist at the IMF. They argue that a looser rein on inflation would make it easier for debt-strapped consumers and governments to meet their obligations. It might also help the economy by encouraging Americans to spend now rather than later when prices go up. ‘I’m advocating 6% inflation for at least a couple of years,’ says Rogoff…who’s now a professor at Harvard… ‘It would ameliorate the debt bomb and help us work through the deleveraging process.’ …Given the Fed’s inability to cut rates further, Mankiw says the central bank should pledge to produce ‘significant’ inflation… That would put the real, inflation-adjusted interest rate…deep into negative territory, even though the nominal rate would still be zero. If Americans were convinced of the Fed’s commitment, they’d buy and borrow more now, he says… In advocating that the Fed commit itself to generating some inflation, Mankiw… likens such a step to the U.S. decision to abandon the gold standard in 1933, which freed policy makers to fight the Depression… Inflationary increases in wages -- and the higher income taxes they generate -- would make it easier to pay off debt at all levels. ‘There’s trillions of dollars of debt, in mortgage debt, consumer debt, government debt,’ says Rogoff… ‘It’s a question of how do you achieve the deleveraging. Do you go through a long period of slow growth, high savings and many legal problems or do you accept higher inflation?’

S&P’s move this week to lower the outlook for Britain’s Credit rating brought the spotlight on the even more disastrous U.S. debt situation. And it doesn’t help the situation that the dollar has found itself under renewed pressure of late, with even the British pound gaining about 5% this week against our currency. Rather ironically, two of our nation’s prominent economists called this week for the Federal Reserve to move even more aggressively to spur Credit expansion and stoke inflation. It is difficult to comprehend how – with Credit and inflation lessons that should have been learned by this stage in the cycle - inflationism remains so ingrained in economic orthodoxy. Yet the long and sordid history of inflation should have had us on guard. Inevitably, the typical policy response to the hardship wrought from an inflationary Credit boom is the hope for some positive impact from one “final” bout of inflation.

I’ll commence this week’s discussion making the point that the issue is not whether the U.S. “inevitably” loses its AAA rating. Rather, the focal point of the current economic debate should be on whether our well-intended policymakers (fiscal and monetary) have charted a course that risks bankrupting the entire economy. I’ll continue to argue that the paramount policy priority should be avoiding such an outcome. And I will add that there is ample confirmation these days of the inherent propensity for inflationary developments to proceed toward the worst-case scenario.

Dr. Rogoff, advocating 6% (consumer price) inflation, believes a rapidly rising price level would “ameliorate the debt bomb and help us work through the deleveraging process.” I disagree on both counts. Trillions of government debt issuance only worsen potential “debt bomb” consequences. There is a school of thought that holds that policymaking is today lessening the debt service burden. This may be somewhat true for the household and financial sectors. I would argue, however, that the benefits to American households are actually far outweighed by the systemic risks associated with the redistribution of multi-Trillions of debt and assorted risks to the Federal government (inclusive of the Federal Reserve). And this is an especially inopportune time to aggregate escalating systemic risk in Washington.

This aspect of the “debt bomb” – or, in my nomenclature, Credit Bubble Dynamics – is not readily discernable today. While federal debt will likely expand an astounding 13% of GDP this year, the optimists take comfort that total federal debt as a ratio of GDP is not yet at a problematic level (and much less than Japan!). Yields are rising, but Washington has no problem selling its paper today. Nonetheless, a crisis of confidence in the Treasury market would be catastrophic. The consensus view believes that Fed-induced low mortgage rates (and resulting refinance boom!) are spurring system repair. I would argue that the associated massive redistribution of mortgage risk (Credit, interest rate and liquidity), especially to the failed GSEs, is a real time bomb.

Dr. Rogoff and others believe policymakers are these days “ameliorating” the deleveraging process. My analytical framework takes a contrasting view. The critical “deleveraging” process at this point would amount to weaning the U.S. Bubble Economy off of its currently required $2.0 Trillion or so of annual Credit growth. The issue is at its heart embedded deep within the economic structure and will not be cured through additional credit inflation. Current policymaking is shifting the debt burden from the private sector to the federal government sector - and, in the process, increasing the total system (non-productive) debt burden by another $2.0 Trillion or so annually. Moreover, I would argue that this momentous government (Fed and Treasury) intervention in the pricing of finance further corrodes our system’s process of allocating financial and real resources. The “debt bomb” is not being diffused. Rather, the fuse is being somewhat lengthened as the bomb enlarges.

Professor Mankiw believes that if U.S. consumers understood that prices were going to rise they would borrow more and accelerate purchases – and this would better our economic plight. But our economy doesn’t produce enough of what they would likely want to buy, so our current account deficit would rapidly reflate. The dollar is already weakening, which means upward pricing pressure for imports (not to the benefit of the household sector or for system stability more generally). Besides, I would argue that rising inflation expectations lead quickly to purchases of foreign stocks, bonds, gold, energy, commodities and other “undollar” assets. As we’ve witnessed in the markets over the past few weeks, the latent (weak dollar-induced) inflationary bias in non-dollar asset-classes can emerge and quickly feed on itself.

At the end of the day, it is our maladjusted economic structure in concert with speculative market dynamics that will likely dictate future inflationary characteristics. The notion that there is a system price level easily manipulated by our monetary authorities to produce a desired response is an urban myth. During the 2000-2004 reflation, I would often note that “liquidity loves inflation.” The salient point was that the Fed could indeed create/inflate system liquidity. It was, however, quite another story when it came to directing stimulus to a particular liquidity-challenged sector. Almost inherently it would flow instead to where liquidity -and resulting inflationary biases - were already prevalent.

If the dollar bear has resumed, the global inflation/Monetary Disorder issue could quickly reemerge. Federal Reserve efforts to reliquefy our system would be expected to prove self-defeating in a backdrop of significant dollar and Treasury market weakness. Such a scenario would expose what I believe is a major flaw in the conventional economic view that there is a trade-off available between the difficulties inherent to a long economic workout and the acceptance of a higher level of inflation. I fear the current policy path ensures an especially arduous and protracted adjustment period – along with myriad problems associated with an unwieldy inflation backdrop.

I also want to take exception with Professor Mankiw’s likening of a Fed push toward higher inflation to the decision to abandon the Gold standard in 1933. This gets back to the disagreement I’ve had with the “inflationists” for years now: In the name of Keynesian economics, inflation proponents have repeatedly called for massive stimulus in response to the bursting of THE Bubble, while in reality this activist policymaking was instrumental in only extending and worsening a systemic Credit Bubble. This was especially the case after the bursting of the technology Bubble and is again true today following the bursting of the Wall Street finance/mortgage finance Bubble. Now, more than ever before, “Keynesian” inflationism is THE Bubble. When it eventually bursts Washington policymakers will have little left to offer.