DEFLATIONARY WINDS BLOW ACROSS MARKETS AS WORLD REBUFFS THE FED / SEEKING ALPHA ( VERY HIGHLY RECOMMENDED READING )

Deflationary Winds Blow Across Markets as World Rebuffs the Fed


by: David Goldman

November 16, 2010 

Yesterday morning I wrote, “the prudent thing to do is to increase cash positions.” I have been selling off my gold and commodities inflation hedges aggressively since then. The world has told the United States in effect that it will not absorb the monetary inflation that the Fed promised with QE2. The result is a wintry deflationary wind blowing across all markets.


In forty years of watching financing markets, I have seen nothing like the global jeer at the Fed’s proposed quantitative easing – not, in any case, since the US de-linked the dollar from gold in 1971. Even in 1980, when then Fed chairman Paul Volcker returned from the October IMF meeting in Belgrade and pushed the fed funds rate into double digits, criticism of the Fed was muted, and made behind closed doors. Now the German finance minister is calling the Fed “clueless” in the newspapers and the Asians are threatening exchange controls.


In any number of ways, the market is telling the Obama administration that it can’t keep expanding US debt indefinitely. That was the message from the president’s bi-partisan Deficit Commission last week, which called the debt expansion a “cancer.” That was the message from China’s leading rating agencies, which downgraded US debt to A+. That was the message from Moody’s, which threatened to put Treasuries on negative watch and possibly remove their AAA rating. And that was the message from the G20, which threatened to erect exchange controls to keep unwanted dollars out.

QE2 has turned into Titanic One. The Obama administration and the Fed have run into an iceberg. Quantitative easing did no good for the US economy – which means the rest of the world would obtain no benefit from additional exports to the US – but it played hob with markets around the world.


Governments are out of capacity to spend. The British government’s draconian budget cuts were the first frost of the new deflation. Europe’s PIIGS will be forced to cut spending drastically. And American politics is swinging in this direction. The single issue that held the improbable Tea Party together is government spending. The same Baby Boomers who benefited from inflation during the 1970s as their home prices rose have become a classical creditors’ party, fearing with justification that their pensions will be destroyed by a government that uses the time-honored trick of debasing the currency to reduce its obligations.


It is still unclear how the political forces will coalesce to force changes in government policies. Moody’s, the Chinese monetary authority, the German finance minister, and the Tea Party are not going to rent a hotel ballroom and plan a joint strategy. But there is now a critical mass of opposition to Keynesian monetary stimulus and quantitative easing, sufficient to convince the market that the wind has shifted.