Head Fake

Take my money, my cigarettes
I haven't seen the worst of it yet
--Talking Heads

Recently we highlighted a well thought missive by John Hussman. He includes a particularly salient paragraph that bears repeating here (boldfaced emphasis mine):

"From an inflation standpoint, it is important to recognize the distinction between what occurs during a credit crisis and what occurs afterward. Credit strains typically create a nearly frantic demand for government liabilities that are considered default-free (even if they are subject to inflation risk). This raises the marginal utility of government liabilities relative to the marginal utility of goods and services. That's an economist's way of saying that interest rates drop and deflation pressures take hold. Commodity price declines are also common, which is a word of caution to investors accumulating gold here, who may experience a roller coaster shortly. Over the short term, very large quantities of money and government debt can be created with seemingly no ill effects. It's typically several years after the crisis that those liabilities lose value, ultimately at a very rapid pace."

Dr John thus explains why we can realize deflation despite gargantuan increases in money by the Fed. This explanation also tells us why yields on Treasuries go down in the face of huge increases in US govt debt.

The nasty thing is that bureaucrats use goods/service prices and bond yields as signals that they might be overdoing the stimulus. As long as those signals don't exhibit significant upticks (which they likely won't for a while), policymakers feel they have room to step harder on the accelerator.

This sets us up for a big reversal down the road. But as the good doctor suggests, we may be years from the transition from deflation to inflation.

position in gold