Tipping Point

It seems like only yesterday m* was receiving angst ridden calls and despairing messages from market participants of a certain disposition over the Fed's rate deliberations earlier this week. "I can't believe they are going to do this again!" many of them went - a lament all too familiar to readers with dollar savings and insufficient appetite for the likes of China H's, Google, and Gold, not to risk capital but to protect it!

When after four years of steady decline, the dollar plums new depths against third world scrip and plain old rocks and minerals every day for two months while the official story of benign inflation, strong dollar, and credit containment continues to go un-examined as long as something is moving higher somewhere, even m* is at risk of losing perspective on the proceedings.

Standing over the sink with a toothbrush yesterday, dazed perhaps by the carnage effected on the central store of value in the whole incredible system, m* mentally reviewed the long line of casualties who clung to their rational thought processes too long in the face of this paper bull and contemplated the unthinkable, capitulation.

Were it not for this astonishing and subversive little piece entitled "Inflation-Lessons From History" from Morgan Stanley's Joachim Fels, m* might still be there, brush in hand.

"Since the anchor of the gold standard has been lost, the price level has had only one direction: up. Deflation is virtually ruled out in our paper currency system, and risks to prices are almost entirely on the upside. This is because central banks have become very averse to deflation, and because they usually don't correct for upside one-off surprises for inflation."

Now that's hardly Fiat Money Inflation in France but for a sell-side monetary strategist (as well as a pretty good sport in the old Frankfurt office) it is pretty telling. It also is exactly what m* has been thinking to make sense of the current conditions. It's not just a profligate Fed. Or the inexorable forces of Globalization. Nor a sick Japan or even a scheming China. Though it is very much all of the above. The issue is greater than all of those. It is the matter of paper money.

Mr. Fels is of course too kind to Central Bankers (he knows quite a few) in presuming that they actually have a choice. In m*'s way of thinking, under fiat money, deflation is not merely "ruled out." It is simply impossible. Only inflation, or reflation are possible developments. Or, as m* heard from one wisened FX hand talking about Citigroup today, "Everyone is talking about the banks shrinking. Banks can not shrink. They can only get bigger!" The invisible hands of the system in an open economy with fiat money are too strong for any individual institution acting independently to resist. Unfettered credit creation and socialized monetization of that credit are inevitable. The idealized notion of a Central Bank soundly managing a money supply, resisting inflation and currency debasement is simply wrong.

Right on schedule The Big Picture this week went back to first principles:

"Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth."

--John Maynard Keynes
The Economic Consequences of the Peace, 1919. pp. 235-248.

What would he make of the AMT and 15% dividend and capital gains tax relative to ordinary income at 35% to 50% after state, local, social security and those non-tax taxes medicare, and medicaid?

m* has been off kilter for weeks wondering how long the disconnect between what was perceived and what was real could continue, (Keynes got that one too) - or how to suspend judgment long enough to participate with the crowd as the bear resignations flow in. The FT's John Dizard caved yesterday: "All Elements in Place for an Equity Bull Run." Alas it was not to be. And a good thing too.

The credit crunch is indeed back and it seems awfully hard to see how more cheap money is going to help (though of course it always helps). No the bigger issue is that the long run futility of efforts to reign in rising prices, to ignore the simple reality that the enormous economic orthodoxy is built to ignore, and the little understood but fundamentally important inflation expectations are on a collision course.

For those who have paid close attention, the tipping point for the housing bubble is well past. The tipping point for the credit bubble is recently past. The tipping point for the dollar collapse is an ongoing event. Today, markets got a glimmer of insight into what it all means. The containment story is slipping away. Faith in price stability is slipping away.

When the 99% of folks who expect and rely on a stable store of wealth as fair trade for their labors come to understand that they have been had, times will get very interesting indeed. m* thinks the scene this week signals that tipping point.

It's a new world.