Break It Down Again

When it's all mixed up
Better break it down
In the world of secrets
In the world of sound
--Tears for Fears

I've heard a few folks claim that what we're experiencing isn't deflation, but a period of de-leveraging. They go hand in hand, of course. Deflation is contraction in the quantity of money and credit. And credit contracts via a process of deleveraging.

Our monetary system is tilted way towards the credit category. Credit means borrowing, and when you've borrowed, you're leveraged. You've borrowed to 'lever up' potential returns. These potential returns could be financial, or, more broadly construed, could represent targeting a lifestyle or standard of living that couldn't be achieved without borrowing.

Leverage works both ways. When market winds are at your back, returns are magnified. But when market winds face you, losses are magnified. As such, leverage increases risk.

Broad market headwinds have turned leveraged market participants into net sellers. They need to sell to de-lever, cut losses, and reduce risk. And they're selling everything. Stocks, bonds, real estate, oil, gold, commodities.

These broad price declines are a consequence of the de-leveraging, or deflation.

After the Fannie Mae (FNM)/Freddie Mac (FRE) 'bail out rally' yesterday, hard selling resumed today as chatter got loud of next shoes to drop. Lehman Brothers (LEH) may be next, as the stock tanked nearly 50% today on huge volume to close in single digit midget territory.

Observing the current price action, I can't help but think that, if we're approaching a time where a bunch of leveraged players simultaneously decide it's time to hit the eject button, then a major stock market dislocation may be eminent.

positions in oil, gold