This Sunday Funnies cartoon is courtesy of Merle Hazard who says “We Can’t Go On Together with Suspicious Minds, Because Were Leveraged too Much Baby”

Concept by Merle Hazard, Art by Grey Blackwell. The cartoon also appeared on Jon Shayne’s Blog.

Here is a list of Songs and videos by Merle Hazard, not to be confused with Merle Haggard.
Inflation or Deflation?

http://www.youtube.com/watch?v=2fq2ga4HkGY

Link if video does not play: Inflation or Deflation
Mike  “Mish”  Shedlock  – Global Economic Analysis

The bond market figured it out immediately, pricing it in.

That’s the 10 year Treasury on a weekly chart.  It is now back to effectively where it was in the depths of the crash.

The 5-year yield is below that of the crash.

And the 2-year has basically been turned into a T-bill.

The bond market is telling you that there will be no material economic growth for the next two years and that a deflationary depression is the economic path that will be followed.

This is effectively what happened in Japan, although the worst of the economic impacts have been muted as they had tremendous internal surpluses to expend (those, incidentally, are now pretty-much “used up” – two decades later.)  We do not have those internal surpluses – to the contrary.

The stock market has been doing plenty of “up and down” and it will probably rally for a bit yet, as stock traders tend to be the short bus riders.  But make no mistake – the bond market’s response to the FOMC announcement is entirely rational and consistent with only one outcome – a sustained economic slowdown coupled with deflation, not inflation.

What will cause this?  The debt bubble collapsing.  Maybe kicked off by Congress failing to reach agreement or doing a “nothing” with the so-called “commission.”  Maybe kicked off by collapsing net interest spreads for the banks and then their collapse from the weight of their bad loans and inability to earn their way out of the box they’ve painted themselves into.  Or maybe Unicredit blows up and the tsunami comes from Europe. There are plenty of things ticking out there, and it only takes one big one that goes off to set the next move in motion.

The bottom line is that either the bond market is wrong or stocks are wrong.  Given that Bernanke just provided you his pronouncement and expectations, I wouldn’t bet against the bond market, and if the bond market is right then the modest “mini-crash” we just saw is a warning and not a buying opportunity, just as Pompeii’s Vesuvius rumbled many times before it blew its stack.

When this is priced into the equity markets – and others – it is likely to be in the form of a nasty dislocation.  This also fits with the technical picture; assuming the low today of 1103 holds for the moment and is a localized low then the most-likely retrace is up around 1220, all in the S&P 500.

The next move down, unfortunately, should comprise almost four hundred S&P points and close to four thousand DOW points, and is likely to be more violent than what we just experienced.  It could be worse too – it’s possible that we see an S&P decline of more than six hundred points, basically cutting the indices in half, more-or-less “all at once.”

Enjoy the rally today (and likely for a bit yet on a forward basis) but beware – if I have to choose between the stock market and bond market as to who’s right the bond market is almost always both the leader and the correct choice.

It’s Russian Roulette for the Washington Set

“I know what you’re thinking; “Did he fire six shots or only five?”  Well, to tell you the truth, in all this excitement I kind of loast track myself.” — Harry Callahan

NEW YORK (MarketWatch) — The more things change, the more they stay the same.

I shared some foresight in September 2007 and while some might view the vibe is out-dated, I would humbly counter that it’s not only relevant; it’s increasingly cumulative in cause and effect. See: Russian Roulette.

And I quote:

“After years of focusing investor attention on the risks of inflation, the market demanded — and the Fed delivered — a policy shift designed to alleviate credit market pressures.

In doing so, they effectively told foreign holders of dollar-denominated assets that every nation must fend for itself. That, when push comes to shove, the devil we know — inflation — is more palatable than the devil we don’t.

As the dollar slips to multi-year lows, it is incumbent on us to understand the implications of this policy sea change.

First, it would be helpful to familiarize ourselves with the underlying basics of the dollar dynamic. Kevin Depew wrote a fantastic primer that should be required reading for anyone trying to get a better grip on the subject. See: Five things you need to know about the dollar.

For the last few years, while hiding behind the beard of hawkish vernacular, the FOMC has printed and pumped massive amounts of money into the financial system. That liquidity, while providing a rising tide for virtually every asset class, has come with a cost.

It’s been my long-standing belief that we will continue to toggle between “asset class inflation” and “dollar devaluation.” While both could manifest, I don’t foresee a scenario that includes both a stronger dollar and higher asset classes.

The Federal Reserve, if given the choice, would opt for hyperinflation over watershed deflation. With inflation the rich get richer, the poor get poorer, and the middle class steadily erodes. With deflation, everyone loses. See Pick a Side: Inflation or Deflation .

Wasn’t it Billy Ray Valentine who said that the best way to hurt rich people is by turning them into poor people?

We’ve been monitoring this evolution since 2002, opining that the 30% run in the S&P has been masked by the 33% decline in the greenback. That hasn’t mattered to “us” but it’s the central tenet of foreign angst and a seed that will sow protectionism and isolationism.

Think about it — if you’re a foreign central bank that bought the S&P in 2002, you’ve lost money on the margin. That’s the chief beef with the dollar being the world reserve currency; while we’re enjoying the benefits of our economic “expansion,” they’re sucking wind in local currencies.

That may seem like an obtuse perspective but it’s pertinent in the context of the globally intertwined economy. Americans have been slow to embrace the notion that our basis of valuation is eroding. We earn, spend, and save dollars so, apples to apples there was little impetus to pay attention.

However, as globalization was the perceived catalyst on the front of the tech bubble, it stands to reason that it’ll be a culprit on the other side of the ride. International investors own more than 50% of total US debt, which basically means that they’re holding the trump card on stateside policy.

In our finance-based economy, the velocity of money and elasticity of debt are essential ingredients to the upside equation. That is the crux of the credit crunch that brought this conundrum to bear; money stagnated and credit seized. The global response, verbally and structurally, was to shock the patient back to life.

All things being equal, a decline in the dollar could be “asset class positive,” much as it has been for the last five years. But if the greenback catches a sustainable bid, it’ll likely serve as a clarion call that something entirely more disturbing is afoot.

At the end of the day, our financial health becomes a question of how far the dollar will fall before foreigners scream “Uncle Sam” and, by extension, unwind dollar-denominated positions without committing the financial equivalent of hari-kari.

And it leaves us, investors, in the unenviable position of gaming an invisible catalyst. For regardless of whether we’re wading into inflation, deflation, or both, we’re left to wonder how many weapons the Fed has left in its arsenal.

For when they arrive at the last bullet in the gun, it will likely be pointed inward.”

Fast-Forward to Modern Day

If the last bullet in the Federal Reserve arsenal is indeed pointed inward, wouldn’t that be triggered by a crisis of confidence?

And wouldn’t that start with a negative market reaction to intentionally placed “positive” news, be it resolution surrounding the debt ceiling or an unveiling of QE3?

This isn’t a vibe for today, per se; I’m just putting it out there. The Bernanke Put is a walking, talking contradiction; it will arrive if the economy falters, but the economy won’t improve without stimuli (or, it hasn’t yet, despite oodles of infusions).

The definition of frustration is doing the same thing over and over again and hoping for a different outcome. That also happens to be the definition of “stuck.”

As employment and housing continue to flounder, folks are waking up to the fact that there’s the market… and there’s an economic reality. There’s inflation in things we need (food, energy, education) and deflation in things we want (laptops, plasmas, cell phones) and most of America is stuck in the middle with you.

Bottom line: Policymakers have a God Complex and the simple truth is that nobody is bigger than the market. See: God Complex

It’s clear that they — and “they” includes European policymakers — won’t willingly give up the ball.

The market will have to take it from them.

Todd Harrison for MarketWatch

The facsimile of U.S. “growth” now depends entirely on Central State manipulation and stimulus of risk trades and financial slight-of-hand.

The U.S. economy has become increasingly dependent on asset bubbles, financial legerdemain, credit expansion, Federal borrowing and the manipulation of risk trades to maintain the illusion of “growth.” Compared to an economy based on organic demand and productive growth, the current U.S. economy is a travesty of a mockery of a sham, and has been since 2001.

There are a number of factors at work, but let’s start with two: the ratchet effect, and the Keynesian Project.

In the ratchet effect, increases are easy and resistance-free: it’s incredibly easy to hire more employees in bureaucracies, for example. But once the ratchet has advanced, it is nearly impossible to return to the previous tooth in the gear.

So for a city government to expand payroll from 10,000 to 20,000 employees was effortless, to reduce a 20,000 person payroll back to 10,000 is exceedingly painful.

The ratchet effect is a key feature of addiction. When one beer no longer creates a “buzz,” then the consumer drinks two, and so on, until a six-pack is the new baseline. Below that level of consumption, the addict gets panicky, for the entire necessity of creating a buzz is at risk of catastrophic failure.

The U.S. economy is now addicted via the ratchet effect to unprecedented levels of Federal borrowing and Federal Reserve credit creation and manipulation. Let’s set aside the fact that America’s Central State has by some calculations guaranteed some $13 trillion in private financial assets via TARP, AIG’s backstop, the takeover of Fannie Mae and Freddie Mac, etc.–roughly the size of the entire GDP of the nation.

Let’s focus instead on the fact that the Federal government must borrow and spend 11% of GDP ($1.5+ trillion) every year, and the Fed must buy $1 trillion in impaired private assets or new Treasury debt annually (another 7% of GDP) just to create an illusory GDP growth of 2.5% a year. So we’re spending/injecting 18% of the GDP to conjure a “growth” of 2.5%.

That means we’re spending/injecting $7 to create $1 of “growth” in GDP. And thanks to the ratchet effect, there’s no going back now without systemic disruption. Does anyone seriously believe spending $7 to birth $1 of “growth” is sustainable? If so, then let’s eliminate that $1.5 trillion deficit spending and the Fed’s $1 trillion-a-year purchases of impaired debt and Treasury bonds, and see if GDP “grows” via organic demand and production.

Everybody knows what would happen: the wheels would fall off the illusory “recovery.” The “recovery” is precisely analogous to an alcoholic who claims to be sobering up but who is actually drinking seven beers a day to get a buzz when a few years ago he only quaffed two or three a day.

Here is the Keynesian Project in a nutshell. Unfettered Capitalism works in straightforward cycles: the organic business cycle of expansion, overcapacity and overleverege inevitably leads to a credit bust in which those whose borrowing exceeds their ability to service their debt go broke, and the dominoes of overcapacity and credit expansion topple as losses mount and consumption based on increasing debt falls.

Bad debt gets wiped out, along with “pyramid-scheme” type assets (mortgaged assets are leveraged to buy more mortgaged assets) and excess capacity. As production declines, workers are laid off and consumption declines, further pressuring impaired financial assets.

As Marx had foreseen, these cycles increase in depth and severity. Though Marx invoked dialectical theory and history rather than the ratchet effect, the basic idea is the same: Capitalism becomes increasingly dependent on financial capital, and the resultant crises eventually become severe enough to take down Capitalism as a sustainable productive system.

Keynes’ proposed to counter these worsening business cycle implosions with massive injections of Central State borrowing and spending. The atmosphere of fear as assets, credit and consumption all contracted would be replaced by a revival of “animal spirits” (the magical elixir of Capitalism), consumption would be stimulated by direct government spending on capital projects and welfare (fiscal stimulus), and banking credit would be restored via stimulative Central Bank credit expansion (monetary stimulus).

But Keynes failed to grasp what Marx had intuited: the ratchet effect. Once the Central State ramped up deficit spending and expansive credit, then the organic economy became dependent on that new level of Central State spending and credit expansion.

As I described in the Survival+ analysis, in effect the central State rescued Monopoly Capital by partnering with it. This results in a financial/State Plutocracy which “saves” the organic economy by taking control of its income streams, credit creation and financial assets.

That is the U.S. economy in a nutshell: a travesty of a mockery of a sham. The consumer became dependent on easy, cheap credit and home equity extraction to maintain his/her consumption. The student became dependent on easy, cheap credit to fund his/her increasingly costly college education. Monopoly capital became dependent on financial slight-of-hand, the debauchery of credit, fraudulent mispricing/masking of risk, stupendously leveraged bets on risk assets, etc. for its swollen profits. Politicans became dependent on unlimited borrowing and spending to keep the illusions of competence, sustainability and “growth” alive.

State and local governments became casinos, dependent on skimming the profits from asset bubbles and financial fraud. Where did New York City’s and New York State’s rising revenues come from? By playing dealer on Wall Street’s scam tables, skimming a steady share of the profits.

Where did California’s bloated state revenues come from? The skimming of capital gains from the Ponzi-scheme real estate bubble.

The stock market rally circa 2003-2008 was merely Travesty of a Mockery of a Sham Phase I. In those glory years of the Central State/Cartel-Capital manipulation, it only required $2 of stimulus and credit expansion to blow $1 in asset bubble “growth.”

But alas, the growth was bogus, illusory, a simulacrum of organic growth, a house of credit cards and fraud that toppled when one card’s overleveraged precariousness was inadvertently exposed.

Now we are in Travesty of a Mockery of a Sham Phase II. As Marx had foreseen, the crises are ratcheting up: now it’s taking $7 of State/Plutocracy intervention to conjure up a pathetic $1 in “growth.” Both are now totally dependent on the substitution of bubbles and fraud for real productive growth.

What Marx failed to foresee was the Central State’s rescue of Cartel-Capital via a partnership: the Central State is now as dependent on financial capital’s maximization of fraud and credit expansion as the Financial Plutocracy is dependent on the Central State to mask and enable its expansion of income and control.

The problem is, of course, that the system cannot support borrowing and spending $7 to create $1 of “growth” for long: eventually, as in all business cycles, the cost of borrowing will exceed the ability of the borrower to service that debt. That’s what Keynes failed to foresee: the way in which the partnership of Central State and Cartel-Capital requires ever greater credit and State debt expansion just to keep the system afloat, never mind growing.

If I loan you $1 trillion at zero interest, with no principal payments, then the cost of servicing that $1 trillion loan is zero. Pretty easy to service zero, isn’t it? That’s the core strategy of the Federal Reserve and the U.S. Treasury.

That’s been Japan’s “secret” for 20 years: as long as the lenders (the Japanese citizenry and life insurance companies, etc.) accepted near-zero interest, then the cost of borrowing additional trillions has been bearable.

But as soon as that $1 trillion requires a serious interest payment, then the ratchet-effect game ends. We are not there yet, but the endgame is no longer over the horizon.

What will TMS Phase III require? $10 in Central State stimulus for $1 in nominal GDP “growth”? Or will it be $20 for every $1 of bogus “growth”?

The stock market is a reflection of this ratcheting up of Central State/Monopoly Capital intervention and manipulation. The stock market took off in the mid-1990s in the “easy money” era, and that led to the Phase I bust of 2000-2001.

That required TMS Phase II, which led to the next asset bubble in 2007-08, and that orgy of fraud and credit/leverage expansion led to an even more severe Phase II bust 2008-09.

If the partnership attempts Travesty of a Mockery of a Sham Phase III, then the consequent bust should return the stock market to pre-Phase I levels: The Dow around 4,000 and the SPX around 400.

Neither the public nor the Standard-Issue Punditry (SIP) understand the addiction-like dynamics of the Central State/Cartel-Capital partnership’s increasingly ineffective interventions on behalf of a facsimile of normalcy and “growth.” Like the addicted junkie, the Central State/Cartel-Capital partnership is approaching the point where their “high” requires ever higher doses of smack.

Nobody knows when the higher doses finally become lethal, but we do know there is such a point.

Live debate on deflation/hyperinflation, February 10, 9 p.m. EST . Most of you are already familiar with bloggers Stoneleigh of The Automatic Earth and Gonzolo Lira. Both are well-informed, articulate and persuasive, so the exchange on a topic of importance to us all (deflation vs. hyperinflation) is sure to be compelling.

Of Two Minds

Mish Shedlock has an awesome explanation of the price inflation we are seeing in goods that we need right now.  This is not to be confused with generalized inflation or what many people term, ‘hyperinflation’ – most commonly associated with Zimbabwe or Weimar Germany.

I’m excerpting only part of his post here to try to keep this subject as concise as possible.  Please click the link below to read the entire article.

Prices Affected by the “Demand for Money”

In a general sense, if the demand for money drops for any reason, prices will rise. Conversely, if the demand for money rises for any reason, prices will fall.

The demand for money (the desire to hold on to it vs. consume) can change as consumer preferences change. Demographics is one such reason consumer preferences may change.

For example, someone at retirement age and barely scraping by has a far greater demand for money than a young person at age 30 with a decent job.

Here is another way of phrasing the same thing: A person aged 30 with a good job is far more likely to have high demand for the latest and greatest electronic gadget than someone aged 62 scared half-to-death about running out of money in the near future.

Changing demographics is a very powerful “price deflationary” card at this stage of the game. Indeed, Bernanke is doing his best to counteract the increased demand for money associated with boomer dynamics by pumping up actual money supply.

The result so far has not been the expansion of credit that Bernanke wants, but rather a massive increase in the amount of “excess reserves” held with Fed. (Please see Fictional Reserve Lending for further discussion).

In short, banks have no real desire to lend except to a small pool of creditworthy borrowers who have no desire to borrow.

In the real economy, demand for money is high (as evidenced by unprecedented drops in consumer credit). However, Bernanke (with much help from the Bank of China) did manage to ignite more recklessness in numerous speculative ventures including equities, leveraged buyouts, and commodities.

Thus, the Fed can increase money supply, but it cannot easily dictate where that money goes or even if it goes anywhere at all.

Frugality Revisited

The “Demand for Money” construct forms the basis for many “frugality arguments” I have presented over the years.

It is a topic much in need of discussion and understanding, especially by various inflationistas calling for hyperinflation later this year. The good news is we only have 11 more months to see them proven wrong. The bad news is they will simply bump up their target by a year or two.

Cliff Event In Japan

Meanwhile, Japan is the perfect example of strong demand for money in spite of amazingly low interest rates and in spite of all efforts by the Japanese central bank to cause inflation.

Nonetheless, Japan is at a state in its economy where it has consumed all of its savings and then some just as its retirees need to drawn down on savings that the government spent building bridges to nowhere in foolish attempts to fight deflation.

Please see Japan’s Finances “Approaching Edge of Cliff” for details.

As a result of that “cliff event”, strongly rising import prices in conjunction with a rapidly falling currency will likely hit Japan before the same thing hits the US.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

Reader Jed writes ….

Hello Mish,
Here is a humorous image of a sign I took yesterday at the Southdale Mall in Edina.

Jed

Thanks Jed but that store has a long, long way to compete with stores in Japan that sell things for $10 Yen (about 12 cents by current calculation).

Here is a Forex Currency Conversion Link.

¥10 Shops in Japan

Mike in Tokyo Rogers reports ¥10 Yen Shops in Japan! Proof of Deflation!

The Asia Times Online shows what 20 years of Japan’s economic policies have brought us: Severe deflation.

We have ¥10 yen shops selling daily items and doing brisk business in Japan.

The ¥10 yen shops sell loss leader items to attract the customers but the other items sell for about ¥88 each, so they even beat out the ¥100 yen shops.

The store that accomplishes all of this is called the Recycle Garden.

Deflation Dilemma

The article Mike Rogers referred to is Ten-yen stores capture deflation dilemma

With many worrying that the United States economy headed towards a painful Japanese-style deflation, the concept of “Japanization” is increasingly being bandied around the world. But what is “Japanization”?

One answer is found in Kawasaki City, about 20 kilometers southwest of downtown Tokyo. There, a 10 yen-shop called Recycle Garden (equivalent to a 10 cent store in the US) is attracting large numbers of customers by word of mouth. The outlet is one of nine Recycle Garden branches operated in the Kanto region centered on Tokyo and including Yokohama, Kawasaki and Atsugi.

At Recycle Garden, 10 yen buys the customer everyday items such as chopsticks, kitchen goods, nail-scissors, hand sanitizers, or air fresheners. A colored plastic hair clasp is also 10 yen. In the Kawasaki shop alone, the product lineup consists of about 1,000 items at 10 yen, with the number of goods totaling around 30,000. It’s all there.

Surprisingly, most of those products are made in Japan, not in China, Vietnam or Cambodia, from where usually cheaper and lower-quality goods flow into Japan.

“Everything is incredibly cheap,” said Kyoko Yamada, 52, a careworker, who lives in Tsurumi Ward adjoining Kawasaki, who on a recent visit to Recycle Garden bought 10 items such bath agents.

How is such unprecedented price-slashing possible?

The mechanism is this: amid an increasingly fierce pricing war among neighborhood retail shops such as 100-yen convenience stores, Recycle Garden makes bulk purchases of those goods from bankrupt shops and firms as from deceased manufacturing and wholesale merchants. In most cases, on hearing the news about a bankruptcy, Recycle Garden workers dash to the failed firms with large dump trucks, and buy up and take away immediately to their chain store a vast amount of goods.

“We are cutting prices to the bone,” said Tadafumi Fukuda, 41, manager at Recycle Garden’s Kawasaki outlet. “Since we also sell other items at 88 yen and above, 10-yen goods serve as a crowd puller.” The number of customers visiting the shop has increased 20% from a year ago, when the shop started to sell 10-yen goods, he said.

Can this happen in the US? I think it can, no matter what Bernanke thinks.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

Day in and day out I hear it from readers who insist that we are not in deflation and will not be in deflation because prices are rising and continue to rise.

Still others tell me it is illogical for a deflationist to like gold.

When I counter with a discussion about credit conditions I tend to get a blank stare or a comment like “I do not care about credit conditions. I own my home. What I care about are rising prices of food and energy.”

When I counter with falling asset prices and zero percent interest rates on savings accounts I am likely to get as statement like “Who cares, I rent?”, or perhaps “The poor have no assets or savings, all they care about is food prices.”

Really?

Such comments come from those who are not thinking clearly about what’s important. Here’s why:

• In a fiat credit-based financial system, when credit is plunging businesses are not hiring. There are currently 14.9 million unemployed who want a job but do not have a job because businesses are not hiring. There are 2.4 million “marginally attached” persons who do not have a job yet want a job, but are not considered unemployed because they stopped looking. There are 8.9 million part-time workers who want a full time job but cannot get one because businesses are not hiring. There are countless millions of college graduates who are underemployed, working at WalMart, delivering pizzas, or attempting to sell trinkets on eBay, because businesses are not hiring. There a still millions more in college hoping for a job upon graduation who will not get one because businesses are not hiring. This is all related to the ongoing credit contraction.
• When credit is plunging so do yields on treasuries and in turn yields on savings accounts. Those on fixed incomes attempting to live off interest income are screwed. Indeed, many are rapidly draining their principal because they collect no interest.
• Those who have a job, pay for those who don’t. Food stamp usage is soaring and now costs over $60 billion dollars a year.
• When credit is plunging, consumers are not shopping, business earnings are under pressure, and wages stagnate or in many cases outright decline. Even those with jobs and no debt have been affected by deteriorating credit conditions. Public employees had escaped this debacle so far, but that is about to change in a big way, with huge implications.
• When business earnings are under pressure or when business owners face uncertainty over consumer spending trends, businesses cut back on benefits, especially health care. Those with health cares benefits are asked to chip in more of the costs. This too is a function of deflation.
• When profits are weak and business uncertainty high, stock prices do not act well (at least in the long run). Those with 401Ks or personal investments are affected.
• With credit falling and wages stagnant or falling, anyone in debt is likely to have a harder time paying back that debt. Foreclosures rise so do bankruptcies and divorces. Entire families have gone homeless.

So, What’s Really More Important?

Expanding credit (inflation) created an enormous housing bubble, a commercial real estate boom, a rising stock market, and an enormous number of jobs.

Contracting credit (deflation), burst the housing bubble, burst the commercial real estate bubble, burst the stock market bubble, resulting in millions of foreclosures and bankruptcies, millions of broken homes, millions on food stamps, 26.2 million unemployed or partially employed, and countless additional millions who are underemployed.

People notice food and energy prices because they tend to be somewhat sticky. Everyone has to eat, heat their homes, and take some form of transportation at times, but is that what’s important?

No!

In the grand scheme of things, nominal increases in food and energy prices are but a few grains of salt in the world’s largest salt-shaker compared to the massive effects of rising or falling credit conditions.

Yet, every day, someone writes to me complaining about the price of milk (or something else) going up 30 cents or whatever telling me that is “inflation” or that is what is most important.

Inflation/Deflation Definitions Once Again

• Inflation is a net expansion of money and credit, with credit marked to market.
• Deflation is a net contraction of money and credit, with credit marked to market.

Those are my definitions. I cannot force anyone to accept those definitions but they do explain what is happening quite nicely.

Conclusion

Those who think prices are what matters, even those who have no debt and no assets, are simply missing the boat about the importance of credit expansion and credit contraction in fiat credit-based financial system. As shown above, a credit contraction affects everyone, in many ways, and in far more important ways than simple price changes.

The stimulus and bailouts helped the financial economy (for a while), but not the real economy. Because credit dwarfs money supply, trillions of dollars of so-called stimulus vanished into thin air, with no lasting impact on the jobs market.

The inflationists and hperinflationists who ignored credit and focused on money supply alone (or consumer prices) never saw the plunge in interest rates coming or the massive pounding in global equity markets.

Those who knew a credit implosion was coming, got treasury yields correct, the equity crash correct, the rise in the dollar correct, and the strength in gold correct.

Gold does well in times of economic stress, especially in the senior currency – in this case the US dollar. It is the only commodity whose long term trendline is intact from 2000. Gold is money and as money it should do well in deflation in the country of the senior currency. It did.

In credit-based system, especially where credit dwarf money supply, credit itself (and the value of credit marked-to-market on the balance sheets of banks) is of paramount importance.

Those who insist inflation is about prices, as well as those who view inflation as an increase in money supply alone (ignoring credit), are going to continue to get the economic picture wrong.

If you are focused on prices or money supply alone, you are focused on the wrong thing.

In a fiat credit-based economy, where credit dwarfs money supply, changes in credit is what’s important, not changes in money supply, not nominal changes in prices.

It’s as simple as that.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com