The Weekly Report

By: Mick P | Sun, Jun 15, 2008
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Welcome to the Weekly Report. Let me take you on a journey to explain what Ben Bernanke said and why he said it. We look at yields, what they are telling us and why we should listen. Finally we show evidence that the carry trade is crumbling. You will require a hot beverage, peace and quiet and probably a light snack.

Its time for An Occasional Letter From The Collection Agency and this week I am delivering it to your door. We start off by looking at the recent remarks by Ben Bernanke that seemed to catch the markets unawares. Before that though I want you to realise that Bernanke was not speaking "off the cuff", indeed his remarks are part of the well organised execution of what I called the Eggertsson Theory, explained in "The future actions of the Federal Reserve are known. Eggertsson re-visited a question that The Federal Reserve has been mindful of for some number of decades and one that Bernanke himself studied in-depth:

Now I wouldn't blame you for looking at such a question and thinking "more inflation?" but the title of Eggertsson's work is "The Deflation Bias and Committing to Being Irresponsible". It laid out the groundwork for an approach to defuse deflationary forces and how to re-inflate the economy. From my point of view, Bernanke is not worried by inflation but he is absolutely petrified about a deflationary event. The actions of the Federal Reserve have for some years (and well before last summer) been a consistent copy of the steps laid out by Eggertsson in how to avoid a deflationary episode. Bernanke's recent remarks are just another step in that plan. Allow me to quote from the link above:

To be honest, you really do need to read "The future actions of the Fed etc" in full to see the whole picture. (it's on my old blog, not the website) but because human nature is what it is and most of you are pressed for time, I'll plough on regardless.

Again I quote from "The future actions etc":

Many writers connect the bursting of a previous bubble and the actions of the Fed/Treasury in the aftermath of such a bust as causing the next bubble. It is not unreasonable to think that the Fed/Tsy are aware that each "bubble" is not a separate and distinct event but can and do interact. For instance the LTCM debacle led to the issue of a lot of 10 year paper that matures this year. If the debt isn't rolled then the principle has to be repaid, causing pressure within the credit system.

The Fed would be aware of the timetable, even if many other investors had forgotten, and may well have been planning for an LTCM debt redemption failure scenario. With investors being reassured that the financial system was "just fine" after the Amaranth collapse (which was nearly twice the size of LTCM) many would have glossed over the LTCM debt maturing. (As an aside, put 2016 in your diary....) Interestingly Bear Stearns did not get involved in the LTCM bail-out but they did hold a lot of CDS exposure, I'm not directly connecting the LTCM debt and Bears CDS portfolio directly but the coincidences are rather neat.

Back to the point, as I have covered here and in full in the article "The future actions etc" Bernanke was obliged to raise the rhetoric about inflation and inflation expectations as part of the plan to avoid a deflationary scenario. The raising of such a topic by Bernanke had to be seen as credible for it to work and that could only be achieved by prior Fed/Tsy inflationary actions being reflected in the actions and expectations that consumers and business displayed.

By continuing to talk up inflation, either through prices or by mentioning (finally) the dollar connection, he now has room to ready the US and the World for a series of hikes accompanied by a continuing delivery of cash and nominally priced assets. His hope is that the re-flation will stimulate growth whilst the yield curve remains steep but moves higher, especially the long maturities.

This, he believes, will encourage...

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Mick P

Author: Mick P

Mick P (Collection Agency)
About Collection Agency

An Occasional Letter From The Collection Agency in association with Live Charts UK.

For some years now I have written an ongoing letter, using macro-economics, to try and peer into the economic future 6 to 18 months ahead. The letter was posted on a financial bulletin board to allow others discuss its topic.The letter contains no recommendations to buy or sell, indeed I leave that to all the other letters out there and to the readers own judgement. The letter is designed to make us all think about what may be coming, what macro trends are occurring and how that will affect future trends and how those trends will filter down to everyday life and help spot weak or strong areas to focus on for trading or investing.

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