75bps cut: Deflation or Inflation?

First off, I’m a bear on the stock market and the economy, and my reaction to the 75bps cut was that there was and continues to be a massive drop in commercial credit demand. With all these defaults we are seeing destruction of money (because after all money is credit and credit is money) and the unwillingness of various financial institutions to lend out money to each other is resulting in a sharp deceleration of the money supply. Reading this you can get the sense that I’m in the deflation camp albeit we can have some inflationary pressures evolve in the short-term (look at gold that just printed a 9 handle) I don’t think that the market has come to realize what the consequences are from the popping of the biggest credit bubble in history. IMO, we are in the early stages of the credit cycle reseting itself. As a result, I foresee the FFR at zero, the dollar rallying against ALL currencies (as most credit is denominated in dollars), and stock markets in disarray. Some evidence points to the deflation theory coming to bloom such as the 10yr UST only being 6bps lower than it was before the 75bps emergency cut. Remember, the Fed doesn’t set interest rates, it merely follows the market, and the market is telling the Fed that credit is being destroyed at an alarming rate. Don’t be surprised if the Fed cuts another 50bps this coming Wednesday. Inflationists? I welcome your arguments.

Yeah baby. Disarray will expose opportunity.

I think overall I am an inflationist although the idea of defaults (and more broadly valuation risk on all the current debt) causing a decrease in the velocity of money is interesting. While that may be a danger, I haven’t heard anyone from the Fed talking about that directly. All I have heard is something like “Inflation concerns are real but not as immediate as the consequences of some financial accelerator causing an economic death spiral as people lose confidence in the markets and the govt and thus generating less economic activity which causes markets to go down [blah, blah]”. I think your theory is interesting, but I can’t think of a good precedent for valuation risk (and then ensuing liquidity problems) causing deflation (and I think this is more important than the actual defaults). I can think of lots of precedent for rapidly rising energy prices, a trashed dollar, and an out-of-control fiscal policy centered on wars we don’t need leading to inflation. I even saw the Chairman of the Fed all but demand that the govt increase deficit spending. I can’t recall anytime I saw that happen from any central banker anywhere. Monetary interventions are supposed to take 18 months to work. We had the Fed converging an emergency meeting on Monday and changing monetary policy to stop an equity drubbing on Tuesday (that wasn’t about the velocity of money except in that second or third order kinda way). This really does feel like a junior version of 1973 to me and like everyone else, I am a prisoner of my past. I think we’ve made some lousy economic choices - some by the Fed, some by the govt, and some from people who just got carried away with new credit paradigms - and the price is pretty big. There needs to be a decent shakeout and the Fed’s attempts to stop that will just cause us to delay the shakeout and pay with inflation.

Yeah, i think we will pay with inflation, weak dollar and recession and nothing fed or gov can do about it. Although it still will be better then a crash of a stock market for psychological reasons. I’d rather see market decline another 20%, then it crash 10% on a single day. Psychological state of people is a huge thing, and if everyone is pessimistic about the future - thats when real problems will start as monetary and fiscal policies are useless in such situations