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Subject: [doc-jp 74155] Bull & Bear -Deflation
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This is a great piece that give some perspective on where we are in this d=
eflationary story and we must be cautious that deflation is not the true w=
inner in this game of cat and mouse=2E


by Christopher Galakoutis

The collapse of 2008 occurred because the US was clearly on an unsustainab=
le path of excessive consumption and speculation, financed by credit=2E De=
bts are IOU's with repayment terms, which means debtors must pay interest =
to creditors; borrowers therefore are on the hook for the principle as wel=
l as the interest, and the whole system falls apart when debtors are unabl=
e to pay because they 1) don't produce anything, or 2) are denied new cred=
it that becomes scarce when booms turn to bust=2E
Borrowing to consume is debt that is of the non self-liquidating type, an =
issue we have regularly written about=2E As it turns out, this type of bor=
rowing was not limited to the know-nothing consumer and his get-rich-quick=
 schemes this past decade, but government and corporations as well, who, o=
ne might think, should know better=2E The US economy is largely dependent =
on debt and smooth running credit markets=2E In the years leading-up to th=
e collapse of 2008, large US corporations -- many not in the 'finance' bus=
iness but rather industrial type companies -- greedily created finance arm=
s to get a cut of the huge profits being generated by shuffling paper with=
in the ballooning debt bubble=2E

In fact, with a large portion of corporate activity today centered around =
finance rather than production, it is easy to see how so many companies en=
ded up getting into trouble; much of this debt bubble was based on mortgag=
e loan origination -- loans based on home values that were too high and he=
aded for collapse, held by consumers who couldn't afford to make mortgage =
payments at the first sign of trouble=2E

Non self-liquidating debt, in the tens of trillions it turned out, was eve=
rywhere, and is the reason the entire financial system of the US is at ris=
k of collapse=2E The repeal of Glass-Steagall in 1999 allowed financial in=
stitutions to get so large that any suggestion of failure meant systemic r=
isk, threatening the financial system of the entire world=2E The US govern=
ment understood this all too well in late 2008, when it bailed out this "t=
oo big to fail" system=2E It borrowed even more money and handed it over t=
o distressed institutions, guaranteeing some of the bad paper to boot=2E T=
he Federal Reserve, as well as central banks around the world, also got in=
volved in swapping government paper for toxic assets (albeit paper that is=
 expected to be returned to their owners, eventually), as well as monetizi=
ng some of the new treasury issues=2E

It worked, and bought the system some time=2E

But as we sit here a year later, with stock markets rallying for months in=
 the face of horrendous unemployment, it is hard to avoid coming to the re=
alization that these gains have all been one big illusion=2E Not that the =
gains aren't real -- they most certainly are for those who actually sell a=
nd realize those profits=2E But rather, they are simply speculative gains =
derived from the liquidity governments have created in the past year: a li=
quidity rally within a deflationary collapse=2E

With no strings or conditions attached, Wall Street once again created sil=
k purses out of sows' ears, shamelessly shuffling the trillions, courtesy =
of taxpayer bailouts, into enormous profits, and paying itself billions in=
 bonuses in the process=2E Meanwhile, those who saved it from itself conti=
nue to suffer; in a sense, the gains of 2009 belong to the people whose cu=
rrency has been sacrificed as a result of this emergency=2E In France not =
so long ago, this artful plundering of the people -- by both Wall Street a=
nd Washington -- meant the guillotine for the plunderers=2E

But sooner or later, most probably sooner, the jig will be up=2E This is b=
ecause, in our estimation, 2009 will go down as a major inflection point i=
n this country in that citizens are finally rising up and marching in the =
streets=2E Psychology has clearly changed in 2009=2E We saw Ben Bernanke g=
o on 60 Minutes, in a feeble attempt to portray his institution as "one of=
 us=2E" In 2009, Members of Congress from both sides of the aisle are dema=
nding an audit of the Fed=2E We think the government and Fed have hit a wa=
ll, and the people will no longer accept more of the same plundering=2E Th=
eir voices are getting louder by the day=2E

In the weeks and months ahead, it will become clear the US economy is not =
improving, while the unemployment problem in this country continues to get=
 worse=2E The government and the Fed will have failed in their futile effo=
rts to re-inflate the credit bubble=2E At that time, the stock markets wil=
l collapse once more, in a continuation of the deflationary collapse and a=
 replay of October 2008-March 2009=2E That will be the day of reckoning, a=
s far as the government and Fed are concerned=2E

To date, the Fed's monetization and balance sheet growth has clearly not b=
een large enough to cause the US bond market to collapse=2E The Fed has be=
en quite careful in that respect, since it knows the bond market is watchi=
ng its every move=2E The Fed will not try anything funny=2E That is, it wi=
ll not print funny money and take the country towards hyperinflation=2E Fa=
r from it=2E

Some half-brained scheme might be designed to reduce the burden of debt se=
rvice, but the Fed will not willingly destroy itself=2E The Fed did not de=
vise a meticulous program of stealing the purchasing power of US citizens,=
 at crawl speed, for the last 90+ years, enriching itself and its powerful=
 backers in the process, only to see it all go up in smoke, in a gallop, v=
ia the printing press=85

=2E=2E=2EIn a modern financial system based largely on credit, it is simpl=
y not practical for large, complex transactions to be conducted in cash=2E=
 Therefore, paper money, i=2Ee=2E, the dollar bills in our wallets, makes =
up only a small part of today's credit based monetary system=2E With the c=
redit market running into the tens of trillions, if not hundreds, it is cl=
ear that these debts are too enormous to be paid back -- particularly with=
 a paltry one or two trillion in all of US currency and bank reserves=2E S=
ince credit deflations follow credit inflations, it is only after collapse=
s occur that governments are confronted with hard choices=2E Currency infl=
ation, i=2Ee=2E, "money printing" as in Weimar Germany, is but one of the =
choices=2E

The only thing governments know how to do is react to disasters (and they =
don't even do that very well)=2E They are almost never ahead of the curve =
in efforts to avert disaster=2E We had the crash of 2008, and followed tha=
t up with more of the same debt gorging that got us into the mess to begin=
 with=2E But we believe the change in the country's psychology this year w=
ill put an end to such practices sooner rather than later, and requires th=
at we move out of the liquidity driven inflationary camp as a result=2E We=
 don't make this decision lightly, but we don't believe the US will resort=
 to currency inflation, either, for reasons stated above=2E

The reprieve in the markets since March has provided investors with an inc=
redible opportunity to sell into strength, and get out of the way of an ev=
en greater decline dead ahead=2E But for some gold, which is and will alwa=
ys be real money, we advise readers to do the same=2E



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