Setting the Backdrop for Stage Two

Together, the Fed and Washington have effectively nationalized a large portion of both mortgage and market liquidity risk... Sure, the Credit system remains under significant stress, with additional mortgage and corporate Credit deterioration in the offing. But, at least for now, policymakers have successfully stemmed systemic deleveraging. The Credit system is simply not in deflationary collapse mode.

I could not be more pessimistic with regard to our economy’s prognosis. And certainly much more severe Credit problems lay ahead. I could argue further that recent Credit system developments are indeed consistent with the unfolding “worst-case scenario”.

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I tend this evening to see benefits from analyzing the current backdrop in terms of the conclusion of the first Stage of the Crisis. The key aspect of this “first Stage” was a breakdown in Wall Street’s highly leveraged risk intermediation and securities speculation markets. The speed and force of the unwind was extraordinary and in notable contrast to traditional banking crises that track real economy developments.

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I would argue firmly that – in the face of a rapidly weakening economic backdrop - global inflation dynamics coupled with our highly maladjusted economy ensure intractable trade deficits. I would further argue that the current inflationary backdrop will prove an impetus to Credit creation – that then begets only more heightened inflationary pressures. There are certainly indications that the over-liquefied global “system” is not well situated today to handle more dollar liquidity (akin to throwing gas on a fire). Inflation and its consequences have quickly become major issues around the world.