Sunday, 21 December 2008


Many of you will subscribe to the expression "it is always darkest before dawn"; the pessimists will point out "it is always darkest before it gets pitch black". Clearly today a large and growing contingent are pitched firmly in the second camp. Anthropomorphizing the blog, as a historical record to be read in future, I side with the former. But a word of caution. It will get much darker first.

2008 has been mainly about the problems in the balance sheets of commercial and investment banks. That has yet to translate into the full scale of layoffs in the financial and non-financial world. There is going to be a delayed but anavoidable impact on spending and then the second round of belt-tightening.

More signficantly, as the bubble continues to deflate, with the almost audible whooshing of air from the multiple punctures it has now suffered, the Fed seems to be trying to reflate it by installing an industrial size pump which is forcing air back into it at a pace never before witnessed in the history of economic crisis management. The balance sheet of the Fed has trebled to over $2 trillion in a matter of weeks. There is a clear problem with this approach; eventually the punctures themselves will have to be repaired. And when they are an acrobatic feat will be needed also to remove the pump simultanesouly lest the Fed explodes the bubble itself. In economic terms the means of this explosion is clearly runaway inflation.

And this is a feat beyond the abilities of the Fed.  And therefore the idea that 30 year bonds can yield 2.5% in what some think will be a permanently deflated world is likely to be yet another illusion which is going to cost the balance sheets of the holders of US government securities very dearly. Thank the Fed for raising the spectre of the next major financial crisis.

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