Along with the 75bps of heroine the Fed delivered to the junkies on Wall Street yesterday, they also prattled on about the risks of inflation in the Fed statement. This is evidence to me, that depsite all the Fed's moves in recent weeks they still don't fully understand what is going on.
Despite the Fed's best efforts to relfate, a massive deleveraging process is underway. The Fed has predictably demonstrated in recent weeks that they will do anything to prevent that from happening. They have now committed half their balance sheet to addressing the problem and cut the Fed funds rate 300bps.
Deflation across asset classes is the real issue here. House prices are still falling and will continue to do so into next year. Trillions in home equity will be lost, Americans will be forced to save more and consume less (this is a good thing).
However the stockmarket continues stay up on hopes that things are going to be fine with the Fed acting as backstop and business will get back to normal. As mentioned last month Ron Insana is one of the more sane voices on CNBC and summed up the deflation threat perfectly in a CNBC segment yesterday. Click on the image below too watch interview.
If you can't be arsed to watch it, this is the money quote:
I can promise you that if this thing goes farther than it is currently going in terms of the systemic financial risk, we will worry much more about deflation and recession than we worry about consumer price inflation.
Spot on Ronny boy, deflation is the threat. However, I hear you say, currently we have flat or possibly negative economic growth and rising inflation, is that not stagflation? Maybe, but remember that stagflation is just the transition from inflation to deflation. Inflation has a lagging effect, it will eventually come down along with a continued fall in asset prices.