August 17, 2004

I believe I understand the nature of hyper-inflation. Despite numerous complexities, it does very much revolve around the government printing press and uncontrolled fiat money inflation. Yet this dynamic has very little to do with contemporary "money" and Credit. And I think it is important to appreciate that current inflation is also divorced from Federal Reserve "printing" or "pumping." The expansion of the Fed’s balance sheet has been basically inconsequential in comparison to total system-wide Credit expansion.

The Fed does not today "control" money creation. It has, however, been too successful in encouraging lending excess and inciting leveraged speculation. Moreover, the Fed has nurtured the mushrooming of the U.S. financial sector, and with it the "intermediation" of Trillions of risky loans into perceived safe and liquid "money" and Credit instruments. But we need, today, to be very cautious when it comes to extrapolating the Fed’s capacity for inciting sufficient lending, speculating, and intermediation – the commanding forces underpinning today’s key inflationary manifestations. When financial crisis arrives - and de-leveraging and disintermediation commence - the Fed will certainly aggressively expand its balance sheet and incorporate "unconventional measures." But years of runaway systemic excess (not to mention dollar vulnerability) leave the Fed today a rather atrophied and timid little player confronting A Big & Nasty Credit Bubble. The Fed will be surprisingly impotent in ameliorating bursting Bubbles, and the notion of "pushing on a string" will become topical…..

Not only do I view developments over the past two years as having significantly upped the ante on the dangers of Credit collapse, I believe the character of Fed-induced excesses and imbalances have significantly increased the likelihood of markets eventually "seizing up" – the LTCM debacle having provided an omen that should have been heeded. Today, with Bubble dynamics and speculative leveraging at full intensity, any significant move to de-leverage or liquidate dollar exposure would precipitate systemic liquidity crisis. And the way things are currently developing, a dislocation in the dollar/currency markets would appear to pose the greatest risk as the catalyst for such a financial dislocation. Most unfortunately, the contemporary U.S. Credit system has demonstrated zero capacity for self-regulation or adjustment.