The Great Deflation / Inflation Debate

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The Great Deflation / Inflation Debate

The guys at FSN have started a series on Inflation vs Deflation.

They will have four guests giving their side of the Inflation / Deflation debate over the coming weeks.

First person to kick off the debate on FSN was Robert Prechter from Elliotwave

Guest 1: Robert Prechter
View:     Deflationist
Link:      Mp3 - Robert Prechter - Inflation / Deflation discussion
Date:      5th September 2009

He made some quite relevant points as to why deflation is still the order of the day and that the markets are still going to unwind in a big way.

FSN will have two more inflationists airing their view in the coming weeks before another deflationist discusses things from their perspective.

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Re: The Great Deflation / Inflation Debate

Thanks for posting this.  I've often wanted to see or listen to a panel of people arguing in real time about inflation and deflation, and this is as close as I've come yet.  Puplava seems like he leans towards inflation, so he asks a lot of pointed questions.  In my opinion, Prechter won the debate.  I'm becoming more and more convinced that deflation will persist for the next 3+ years before any inflation or hyperinflation kicks in.

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Re: The Great Deflation / Inflation Debate

Deflation Worries Looking More Credible


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Re: The Great Deflation / Inflation Debate
More Deflationary Doom and Gloom 
Sep 11, 2009 08:08 PM

Edwards, The Pragmatic Capitalist cites evidence (here)
that we are about to fall into a deep deflationary period lasting about two years with a cumulative core deflation exceeding 10%.  They show the following chart which shows the two year delayed correlation of core inflation with the ECRI leading indicator.

To bolster their argument they give the following graph that shows the continuing depressed velocity of money in spite of a 50% stock market rally.

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Re: The Great Deflation / Inflation Debate

In the M1 money multiplier chart, the entire three-year period of falling velocity (2004- late 2007) coincided with a steady secular bull market rally.In other words, there was no correlation between velocity and stocks for three whole years. So why should there be now?

Bob Prechter has been arguing for a $200 gold price since the late 1990s. Gold has been going against him for eight solid years. Even if he is eventually right (and I've got several hundred thousand bet on the proposition that he's not), he has been fighting the trend for so long that anyone who stuck to his hard-headed idée fixe has long since been bankrupted.

The answer to the inflation-deflation debate is so succinct, that deflationists can and should have it tattooed on their beetle-browed foreheads:

Money mouth WAR = INFLATION Money mouth

Always has, always will.

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Re: The Great Deflation / Inflation Debate

I just listened to the interview with Peter Schiff.  At the very beginning (I think it was the first question), Schiff recognizes that loan defaults constitute money destruction.  However, he then goes on to argue that money is being created faster than it is being destroyed.

His entire inflationary position is built upon this gigantic assumption, which many besides myself believe to be monumentally wrong.  The rest of the interview and all his other views are either directly or indirectly based on this initial assumption.  

Rather than argue about inflation vs. deflation, I would love to see an in-depth study on money/credit destruction as compared to money creation.  There have been some graphs posted by on Nate's economic edge, Mish's site, and various other sites that imply credit/money is being destroyed at a very high rate, but I have as yet to see an in-depth study and a  direct comparison with money creation.

If inflation is an increase in money/credit and deflation is a decrease in the same, why don't we just figure out what is really happening rather than theorize and postulate?  

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Re: The Great Deflation / Inflation Debate
Farmer Brown wrote:

If inflation is an increase in money/credit and deflation is a decrease in the same, why don't we just figure out what is really happening rather than theorize and postulate?  

Hey FarmerBrown: I totally agree. Having said that what concerns me is the difference between private and public debt aka money creation. Please help me wrap my mind around that. Take care

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Re: The Great Deflation / Inflation Debate

Enough money can be created to overwhelm any deflationary collapse.

I don't mean in the sense of correcting the structure of the economy,
but of causing inflation not only of stock and commodity prices but even of consumer prices.

I believe a crisis is fast approaching where the feds (an abbreviation for the Federal Reserve and the Federal Government) will have to come to a decision on how to handle their cash flow problem: #1 default on the debt, #2 dramatically slash the federal budget, or #3 simply print more and more money.
You could say this has happened already, but I think there will be first something more identifiably critical, like a huge drop in the dollar in a very short space of time - perhaps 10% in a day.

If something like this happens, which way will they go and when will we know it?
This is to me the crucial question.
Looking only at technical details about what's happened so far and trying to extrapolate the future is not going to work except perhaps by luck.
There's got to be some accounting for the ideologies and psychologies of the people involved.

Right now, Bernanke seems committed to buying up whatever debt the Treasury offers that is not otherwise bid for.
What are the best indicators to follow to verify he is going to continue or going to reverse this course?
What are the legal obstacles to the Fed just going it alone?
Or to the Treasury just printing up some big denomination bills to pay off creditors?
Or will they declare a bank holiday and dream up some noninflationary resolution with major creditors?

 

 

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Re: The Great Deflation / Inflation Debate

Here's a couple excerpts from John Mauldin's newsletter.  It's long, but instructive.

http://www.frontlinethoughts.com/gateway.asp?ref=reprint

Quote:

Remember the story of John Paul Jones? An American naval officer during the American Revolution (the French gave him a medal, although the British referred to him as a pirate), he engaged a larger British ship off the coast Yorkshire. He literally tied his boat to the larger ship and they shot cannons and guns at point blank range. Legend has it that he was asked to surrender, as his ship was sinking. He is supposed to have replied, "Sir, I have not yet begun to fight!"

When faced with the possibility of deflation, I can almost hear Bernanke saying, "Sir, I have not yet begun to print!"

When will they know when enough is enough? When the velocity of money stops falling. When we see two quarters in a row where the velocity of money is rising, then it is time to start investing in inflation hedges.

Quote:

There Are No Good Choices

What we are looking at in our near future is not inflation. We are in a period where the Fed is in the process of reflating, or at least attempting to do so. They will eventually be successful (though at what cost to the value of the dollar one can only guess). One can have a theoretical argument about whether that is the right thing to do, or whether the Fed should just leave things alone, let the banks fail, etc. I find that a boring and almost pointless argument.

The people in control don't buy Austrian economics. It makes for nice polemics but is never going to be policy. My friend Ron Paul is not going to be allowed to make monetary policy, although he might get a bill through that actually audits the Fed. I am much more interested in learning what the Fed and Congress will actually do and then shaping my portfolio accordingly.

A mentor of mine once told me that the market would do whatever it could to cause the most pain to the most people. One way to do that would be to allow deflation to develop over the next few quarters, thereby probably really hurting gold and other investments, before inflation and then stagflation become (hopefully) the end of our perilous journey. Which of course would be good for gold. If you can hold on in the meantime.

Is it possible that we can find some Goldilocks end to this crisis? That the Fed can find the right mix, and Congress wakes up and puts some fiscal adults in control? All things are possible, but that is not the way I would bet.

While there are some who are very sure of our near future, I for one am not. There are just too damn many variables. Let me give you one scenario that worries me. Congress shows no discipline and lets the budget run through a few more trillion in the next two years. The Fed has been successful in reflating the economy. The bond markets get very nervous, and longer-term rates start to rise. What little recovery we are seeing (this is after the double-dip recession I think we face) is threatened by higher rates in a period of high unemployment.

Does the Fed monetize the debt and bring on real inflation and further destruction of the dollar? Or allow interest rates to rise and once again push us into recession? (A triple dip?) There will be no good choice. The Fed is faced with a dual mandate, unlike other central banks. They are supposed to maintain price equilibrium and also set policy that will encourage full employment. At that point, they will have to choose one over the other. There are no good choices. I can construct a number of scenarios. All end with the same line: there are no good choices.

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Re: The Great Deflation / Inflation Debate

Here is the problem I have with the idea that the Fed can outrun deflation with "printing":

The amount of debt in the system currently, is the sum total of several decades worth of credit-money creation by the FRB system. The FRB system plays a much larger role in the creation of credit-money than the government or central bank. Without the FRB system running full-bore, the Fed has no chance at creating enough credit-money to counter-act a decade's worth of defaulting debt.

Inflation and deflation are two sides of the same coin. You can't have one without the other, as many inflationists think. The question is, if the monetary system is designed for inflation only, what happens to it when deflation inevitably occurs? And the answer to that question should be a significant component in forecasting what will happen to the USD, something I think the deflationists overlook.

My 2 cents.

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Re: The Great Deflation / Inflation Debate

In regard to Peter Schiffs interview...I agree that a lot of his answers were not well thought-out. In seems like every pro-inflationist always resorts to the argument that the government can inflate at will by simply handing out checks worth X-amount of dollars to the public. If you have to resort to the threat that the government could give everybody a 2 million dollar check to support your argument, then how pathetic is your argument? This is a cop-out argument in every sense, and Schiff was guilty of employing it on several occasions in this interview. 

What would you do with a 2 million dollar check from the government?

I would buy a whole lot of gold and store it outside the country. Then I would pack up my things and move to Costa Rica to hang out with Farmer Brown!

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Re: The Great Deflation / Inflation Debate

We are being consumed by expanding debt, that's why we see deflationary forces.  I think it is highly unlikely that we will see inflation at least over the coming year.

If things continue as they are, we will come to understand what stagflation is and given the choice, inflation would be a welcome alternative.

Larry

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Re: The Great Deflation / Inflation Debate
Jeff wrote:

In regard to Peter Schiffs interview...I agree that a lot of his answers were not well thought-out. In seems like every pro-inflationist always resorts to the argument that the government can inflate at will by simply handing out checks worth X-amount of dollars to the public. If you have to resort to the threat that the government could give everybody a 2 million dollar check to support your argument, then how pathetic is your argument? This is a cop-out argument in every sense, and Schiff was guilty of employing it on several occasions in this interview. 

What would you do with a 2 million dollar check from the government?

I would buy a whole lot of gold and store it outside the country. Then I would pack up my things and move to Costa Rica to hang out with Farmer Brown!

Jeff, I don't see why you believe it would be a cop-out argument.  Bernanke has suggested essentially the equivalent.   That's why he's called Helicopter Ben.   Your idea of buying gold with your two million dollar check and emigrating is that the value of two million dollars would fall in terms of gold or any currency at nearly light speed to a reasonable level.   The effect would to redistribute wealth nearly equally among the population IF the currency still remained the currency, which it wouldn't.   However, if the inflation is done more gradually, you get a Weimar type situation.  Since such situations DO happen, you have to explain why it can't happen here.

 

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Re: The Great Deflation / Inflation Debate

I don't think Schiff's reasoning is a "cop-out", but it does gloss over the importance of credit destruction.  Sure, the Fed can create enough money to compensate for credit destruction, but the question is, is it?  He is just assuming that the amount of printing going on is over and above the amount of destruction, but has no data at all to back up his hypothesis.  I do not doubt that Helicopter Ben has the ability to print until we run out of trees, but the question again is, how much is being printed and how much is being destroyed. 

I like Schiff and follow his vblogs.  I think he will eventually be right, but there may be many years in between.  Again, I wish there were data for us to know what is really going on!

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Re: The Great Deflation / Inflation Debate

IMHO I think that the debt that was created and is now being destroyed is, can and will lead to "deflation".

I think the distinction I'm trying to point out is that our federal debt, the 80 trillion dollar gorilla in the room, isn't being destroyed. Ergo I think we will see the destruction of the dollar.

I think a lot of "defflationist" blogs only look at the debt in the private sector.

Take care

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Re: The Great Deflation / Inflation Debate

Davos,

I see your point, if deflation happens in the public sector (if the government defaults on its debt), the most likely result is a currency crisis. Of course if that happens, the global economic system comes crashing down and the only game in town will be gold. 

Thinkor,

Its not so much that I don't think the government, if faced with a deflationary spiral, can't issue a check to every who files income taxes, they obviously can as they have done it. Was it effective in stopping deflation? Nope. Did it spur economic activity? Nope, the economy fell off a cliff just shortly afterwards. With a private credit market in excess of a $ quadrilion, and the majority of it structured as derivatives, it wouldn't take much of a decline in the the underlying assets to trigger a highly leveraged cascade of debt destruction. I think it is a pipe dream to believe that Bernanke could neutralize this deflationary force by distributing bailout checks to the tax payers. Deflation is more than just an economic theory, its a collective self image. I think the evidence is clear that the consumer's mindset has changed. Bailout checks would be hoarded by the tax payers, just like they are being hoarded by the bankers now. The shock value associated with a sudden large check being issued by the government, would only serve to confirm peoples worse fears and reaffirm their deflationary self-image. 

 

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Re: The Great Deflation / Inflation Debate
JAG wrote:

Davos,

I see your point, if deflation happens in the public sector (if the government defaults on its debt), the most likely result is a currency crisis. Of course if that happens, the global economic system comes crashing down and the only game in town will be gold. 

 

That wasn' my point.

My point was it ISN'T deflating in this sector. I agree with your result. My point is that this debt is the equivilent of about 8 stock markets. It isn't deflating. It isn't payable. It is causing "inflation".

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Re: The Great Deflation / Inflation Debate

Jag & Davos,

This economic difficulty the US is having has been called a "balance sheet recession", ergo a "depression", rather than a more ordinary "inventory recession", but I think a better designation is a "national business model recession".  We've been proceeding as though certain assumptions were certain and written in stone by the hand of God:  the government can never shrink, there will always be plenty of oil available at reasonable prices, the position of the dollar as the world's reserve currency is secure, deficits don't matter, etc.

Though the government sector has not yet been hit by deflation, I think the portents are clear, it too will be going down.  It is our largest bubble.  In some sense the government is an industry like other industries, just much, much bigger.  It has been overhyped and oversold to the point that we are embarking on unrealistic and expensive ventures similar to some of the flights of fantasy during the South Seas Bubble.

This deflation of the government sector (deflation in the sense that the government sector will shrink) can occur with deflation in all the major sectors of the economy even as price levels increase.   At some point we could have an economy divided into two parts #1 the employed people and #2 the destitute.  Prices would be inflating in the employed part and the destitute would be left out.  Price inflation will partly be the consequence of too much monetary stimulus to the employed part, which may still be under deflationary pressures itself, partly due to a falling dollar, which will raise the prices of all goods that enter into international trade, whether imports or exports, and partly the consequence of higher taxes imposed on everything the government can think of as it desperately resists shrinking.

I agree that Schiff doesn't present much evidence price inflation will occur soon, but sooner or later it will, which means sooner or later the price of gold will be much higher.  Perhaps it is best to buy now and not risk being left out.  Worth noting: gold has been most closely correlated to the dollar in the past, because the dollar was the reserve currency.   That might not be so in the future.  I would expect instead gold's correlation with the dollar to fall and its correlation with the yuan and the euro to rise.   I also expect that soon the Chinese and the Europeans will accept that relative devaluation of the dollar is necessary to redress the current account balance problem, and they will lower their own rates of monetary expansion, which have been paralleling the US's.

 

 

 

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Re: The Great Deflation / Inflation Debate

Isn't there the possibility that we could have both inflationary and deflationary pressure in the economy in different sectors at the same time??

Over recent years, we have experienced a massive increase in housing costs (inflation due to excess and uncontrolled credit), whilst at the same time commodities and consumer goods prices have deflated (because of cheap imports from the East). 

With the current situation, we undoubtedly have a huge amount of "wealth" being distroyed as the economy buckles under the weight of debt, causing the collapse in house prices and in non-essential goods (see the price wars on the net and the offers of interest free credit and no payment until 2010).  On the flip side, there are the protectionist policies (China and their rare earth metals), dimishing raw materials, concerns over food supplies etc etc. 

We all know that the inflation stats are highly sceptical and subject to much manipulation and so how does one measure it accurately and what is the accurate picture of the last say 20 to 30 years?? 

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Global Liquidity & Dollar Index Correlation

The following article at Zerohedge (which is referring to an artilcle from Yvs Lamureux of Blackmont Capital), shows the current divergence between global $ liquidity and the $ index is anything but normal.

http://www.zerohedge.com/article/problem-competing-views…

US dollar bears should take notice of the great correlation between global liquidity annual change rate and the dollar index.

We view this big drop as a positive development for the dollar.

It is tempting to get on board with talk of the greenback going into freefall. However if taking a look at the graph one can reflect as to the big picture in the making perhaps then you can arrive at a different set of conclusions.

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Re: Global Liquidity & Dollar Index Correlation

Thanks for that post FB, I guessed I overlooked that one. Suddenly, I don't feel so dumb for being a short-term dollar bull.

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Albert Edwards: "The Global Credit Crunch Is Not Receding"

http://www.zerohedge.com/article/albert-edwards-global-credit-crunch-not...

Click link for full article and charts

I don't see much talk concerning the credit contraction anywhere, including this site, except in generalized conceptual terms.  Edwards provides some history-making charts.  

Albert Edwards: "The Global Credit Crunch Is Not Receding, It Is Intensifying"

Granted, you wouldn't know it if you followed the stock market melt up as the wild rush to eek out any and all P&L before tax loss selling season hits (assuming there even is one this year), but read on. If nothing else, SocGen's Albert Edwards, unlike many others, has stuck to his convictions.

And the core empirical observation, which ties the whole deleveraging concept in a tide little packet which the Fed apparently, no matter how hard it tries to push equities higher, will have major headaches with, is the discussed continuing consumer deleveraging.

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Re: Albert Edwards: "The Global Credit Crunch Is Not ...

OK FB, thats two in a row. I'm thinking I need to be spending a lot more time at Zerohedge.

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Re: Albert Edwards: "The Global Credit Crunch Is Not ...

There is a clear pattern of credit contraction.  And there is no reason to believe that is not a long term trend that has many more years to play out.  It stands to reason that if it took twenty years for credit to expand than it would be reasonable to expect it to take 20 years to contract to reach symmetry or equilibrium.

And yet we are seeing a weakening dollar.  Shouldn’t we expect to see the exact opposite?

So why are both of these phenomena happening at the same time?

Is the dollar weakness only a short term event that will yield to the massive credit contraction headed our way or will both trends continue simultaneously. 

Is that even possible?  If so, how?

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Re: Albert Edwards: "The Global Credit Crunch Is Not ...
npwebb wrote:

Is the dollar weakness only a short term event that will yield to the massive credit contraction headed our way or will both trends continue simultaneously. 

My personal opinion is that both probabilities are correct.

I think we will definitely see a strong rebound in the USD based on market sentiment alone.

But it also looks like the US is following in the footsteps of Japan, despite significant differences in our two economies. Japan has experienced pronounced deflation over the last 20 years with simultaneous weakness in the Yen (due to the carry-trade). Now, we have speculation that a USD carry trade has begun.

Of course, a carry trade implies that foreign investors are healthy and speculating in the global market. If the US falls into a pronounced deflationary spiral, it will most surely drag the global economy down with it, leaving the potential for a significant USD carry-trade unlikely. Also, it seems unlikely the world's reserve currency, a currency that all other major currencies are a derivative of, could serve as a carry trade currency over the long term.

So to conclude, it does appear that the US is following in Japan's footsteps, but most likely our future is much more grim.

Just my thoughts...

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Re: The Great Deflation / Inflation Debate

"A recent piece on the TV news confirmed my suspicions that some of the packaged items in our grocery stores were smaller with less content. The manufacturers have designed new labels for these slightly smaller versions and have kept them at the same or a little higher price. I’ve noticed it in some canned goods and even in packages of popcorn kernels. I wondered why all of a sudden I was not getting the quantity of popped corn we had been enjoying."

http://www2.dailyprogress.com/cdp/lifestyles/columnists/food/article/good_things_in_smaller_packages/36343/

"The last thing consumers need is less for their money. But that’s exactly what manufacturers are providing through another quietly launched round of package shrink. They’re scaling back the sizes of everything from chewing gum to ice cream, decreasing the amount of product without changing the retail price."

http://www.justaskasa.com/wp/?p=911

Hmmm, corporate greed or inflation?

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Re: Albert Edwards: "The Global Credit Crunch Is Not ...
JAG wrote:

OK FB, thats two in a row. I'm thinking I need to be spending a lot more time at Zerohedge.

Their "community" posts stink, but whoever is behind the curtain running the site posts quite a bit of insightful stuff.  The CM site is unique as far as I can tell.  There is a real effort to foster real discussions.  All the other sites I know of seem to have a different model whereby the goal is just to post info, which is often times good, but that's where it ends. 

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Re: The Great Deflation / Inflation Debate

Round 3 of the debate:

This week's FSN podcast is awesome! Still listening to the debate, but it is getting good....

Mish-vs-Amerman

Marc Faber

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Re: Albert Edwards: "The Global Credit Crunch Is Not ...
JAG wrote:
npwebb wrote:

Is the dollar weakness only a short term event that will yield to the massive credit contraction headed our way or will both trends continue simultaneously. 

My personal opinion is that both probabilities are correct.

I think we will definitely see a strong rebound in the USD based on market sentiment alone.

But it also looks like the US is following in the footsteps of Japan, despite significant differences in our two economies. Japan has experienced pronounced deflation over the last 20 years with simultaneous weakness in the Yen (due to the carry-trade). Now, we have speculation that a USD carry trade has begun.

Of course, a carry trade implies that foreign investors are healthy and speculating in the global market. If the US falls into a pronounced deflationary spiral, it will most surely drag the global economy down with it, leaving the potential for a significant USD carry-trade unlikely. Also, it seems unlikely the world's reserve currency, a currency that all other major currencies are a derivative of, could serve as a carry trade currency over the long term.

So to conclude, it does appear that the US is following in Japan's footsteps, but most likely our future is much more grim.

Just my thoughts...

 

Credit contraction = monetary deflation = strong dollar.

That has been the filter I've run this stuff through.

Where or how does this equation break down resulting in a credit contraction and a weak dollar?

Something isn't computing.

Is my monetary model broken or is this part of being in uncharted waters?

 

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Re: Albert Edwards: "The Global Credit Crunch Is Not ...
npwebb wrote:

Credit contraction = monetary deflation = strong dollar.

That has been the filter I've run this stuff through.

Where or how does this equation break down resulting in a credit contraction and a weak dollar?

Something isn't computing.

Is my monetary model broken or is this part of being in uncharted waters?

 

I use the same jig. BUT I watch the public sector debt and obligation loads. IMHO these are what stress the value of the dollar. We print, lenders bail. Put better, we (the worlds largest debtor addict nation with a government gone berserk) borrow what we can and print the rest of the deficit and they (countries who used to invest in us try to get out). 

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Re: Albert Edwards: "The Global Credit Crunch Is Not ...
npwebb wrote:

Where or how does this equation break down resulting in a credit contraction and a weak dollar?

I don't know. I specifically asked this question to Dr. M this week but received no response. Evidently, it can happen (Japan) but I don't understand the mechanism.

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