The Weekly Report

By: Mick P | Sun, Nov 30, 2008
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Welcome to the Weekly report. There is much talk these days about the inflationary bias of the US Federal Reserve, the rationale being all that money being pumped into banks, brokers (RIP), insurance, car makers and so on (monetary inflation) will eventually flood into the economy and cause prices to rise as too much cash seeks too little supply of goods and services (price inflation).

In normal circumstances, I would readily agree that lending on this scale would eventually lead to a hyper-inflationary period, however we live in interesting times, were we are at the mercy of a credit contraction, the likes of which has never been witnessed before. Right now I believe we are entering a period of deflation that must be traversed before we can expect an increase in inflation.

Below are 2 charts showing the total reserves of depository institutions as at the 19th November:

This one shows the recent action:

Total reserves as of the 19th November were $652831Million but total borrowing from the Fed was $725177Million. In other words the reserves do not meet the liabilities, what we would call insolvent. The borrowing is to offset losses, to re-capitalise the Bankers et al who have blown the lot on dodgy derivative purchases, debt liabilities and the default of borrowers. The following table from the Fed shows the massive increase in lending since October '07:

The Fed is replacing cash and cash like assets that have been eradicated either as a direct loss or through a devaluation as assets are savagely re-priced lower. The funds are not an addition to the amount that can be used to create credit, they are a replacement for the losses incurred by the re-pricing of risk and the closure of credit facilities. The Fed will continue to throw cash into the bottomless pit of debt destruction but this is not inflationary, it is not adding to the availability of funds, just replacing them.

We should remember, the Fed is lending out the funds, it will want the money back. Banks and the rest of the borrowers are being given time to sort out their positions and extract as much profit as possible to allow them to make up the shortfall. Those profits will go straight into the reserves, they will not be used for investment to expand business. As the profits will essentially come from the pockets of the consumers the amount of cash in circulation will fall unless the Fed replaces the shortfall by printing or the US Treasury directly parachutes cash into the accounts of the consumers. Again, these actions are not inflationary, the direct cash injections will be replacing the cash withdrawn from circulation as it sits in the reserves of banking and corporate America.

Yet the future inflationary expectations of many are not mis-placed. There is good reason to think that inflation may well be the deliberate, planned outcome of the US Fed and Treasury actions. We know that the Fed will just about accept anything as collateral to allow borrowing to take place. It is this willingness to expand lending, coupled with the increase in debt liabilities of the Government that make many think the only outcome can be a future increase in inflation. Indeed it is vital for the Fed/Treasury plan to work that such future expectations exist. As I wrote in An interpretation of The Deflation Bias and Committing to Being Irresponsible by G B Eggertsson:

We are being groomed to expect inflation in the future so that current spending, investment and future planned spending are based upon an inflationary bias. It is an attempt to circumvent the problem the Japanese suffered, that even when Quantitative Easing (QE) was in full flow, there was no change of behaviour from a deflationary mindset to one where inflation was expected. We are at that stage now and it is why I was not surprised by this:

It is the bias of Kohn's statement that is interesting. A policy of QE means you are in a situation that is deflationary and you are attempting to inflate out of such a scenario. It also intends to make the mindset of all market participants change to an expectation of a future inflationary environment. Kohn downplays the deflation risk even when he admits that the Fed has implemented an anti-deflationary policy.

Where does this leave the Dollar and by implication all dollar based assets?

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Mick P

Author: Mick P

Mick P (Collection Agency)
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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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