* By Polar Bear
In spite of all the efforts of governments and central banks worldwide, a broad credit contraction is underway and it will continue until savings start to grow again. There is some muddled talk about money printing leading to hyperinflation. It is perfectly true that central banks are pumping money like there is no tomorrow into the banking system, and politicians seem hell-bent on propping up failed companies such as GM, Ford and Chrysler with direct loans, but authorities cannot force banks to lend, nor people to borrow. This is what is termed, 'pushing on a string.' Historically, there appears to be an inverse relationship between the money base and broader credit aggregates. Following the 1929 crash, expansion of the money base accompanied credit contraction. Then, as now, the Federal Reserve was seeking to fight the contraction.
Proponents of the hyperinflation thesis point to the vertical rise in the money base as validation, but the speculative boom, preceding the 1929 crash, was accompanied by a money base decline. Similarly, the money base was declining prior to the recent stock market top.
In addition, there is no way that Treasury Bill rates could continue to decline in the face of impending inflation. However, it is erroneous to analyse the yield on the US 10 Year Note, or the 30 Year Treasury Bond, simply in terms of inflationary expectations. If inflationary expectations were high, yields on both Bills and longer dated Treasuries would rise. It should never be forgotten that both 10 Year Notes and 30 Year Bonds are financial assets, whose prices are only sustained by injections of liquidity. Thus a continued deflationary credit contraction should adversely impact prices of long dated Treasuries. Already, we see that steepening in the yield curve in the current contraction.
That flight to quality story still holds sway in the continued rush into 30 Year Bonds. But market participants will learn the hard way that real money rises in value during deflations, not financial assets. Contrary to the conventional received wisdom, gold rises in real terms during contractions and underperforms during economic expansions. Witness its performance in relation to industrial metals and silver, (a semi-industrial metal), since the start of the current contraction in 2007.
As economists of the Austrian School have argued, the problem is not the bust, but the preceding boom. The current deflation, like all previous deflations, will continue until equilibrium is restored between savings and the demand for credit. Governments and central bankers may claim that this time it will all be different. Yet all their efforts to boost consumption and attack thrift are only replays of old delusions. In the real world, Mr Market and Mr Margin Clerk continue to hold sway.