Here at biiwii, I have personally been writing about deflation from the humble beginning, which admittedly is only last summer, but became more strident about it in December, starting with Got a Funky Feelin'. Analysts I respect, such as Steve Saville, have been tracking the current deflation "scare" for even longer. I must tell you that, as one of the "fringe" types alluded to in another commentator's very recent article, I am on high alert for continued DEFLATION or THE BEAR IS BACK type headlines. Right now, it seems that nearly everyone is following the trail of bread crumbs the Fed is leaving. Following the obvious path that everyone knows will lead the way out of the woods. I should note that in my personal (non trading) accounts, I am not fighting the Fed either, but rather diversifying and walking a middle road between gold/silver ETF's/CEF's, short term treasuries, global bonds and cash. But this tact will only apply until the picture becomes more clear, and the time to make a stand arrives.

As stated in this space many times, a true deflationary spiral CAN NOT be allowed to take hold now. We are too far out on a rotted limb, and if it snaps, the whole sordid mess falls to the ground in one big heap. I will watch the USD's daily progress, the bond market's ongoing dance with the Fed, the cracks deepening in the largest and most dangerously leveraged of America's corporations, the relationship between gold and the miners, and of course those deflation headlines for indications as to the duration of this deflation "scare."

The Fed is telling us that they will continue to remove accommodation at a measured pace. Those who have charted the course of the enormous liquidity bubble that they have accommodated thus far, know that this is all for the headlines. Every time I hear a mortgage ad on the radio touting "interest only" or "Poor credit? No problem!" or "shouldn't YOU own a piece of the American dream?," I want to hurl (the radio out the window!). Something for nothing does not work, people.

But I digress from the main theme. The damage has been done, and now the name of the game is financial survival. Following the Fed's bread crumbs is fine in the short term, as I am sure that the term "don't fight the Fed" was borne of someone's painful experience. But in the big picture, one may want to consider that the Fed created the overflowing punch bowl they're now trying to take away; politicians always want to do what is most popular and America has become a country that seems to value feeling good above all else. This is a recipe for inflationary policy, in the guise of fighting the dreaded deflationary forces.

We "fringe" types will be watching for Ben Bernanke's helicopters after we see enough "Deflation" and "The Bear Is Back" headlines. As stated previously, I see two paths left open. First is the obvious where the Fed continues to drain the swamp, triggering a painful and enduring deflationary progression as truly awesome levels of debt and leverage are unwound. The second is the path human nature would dictate, following the instinct for (financial and economic) survival, down the happy road to inflation, whereby the ongoing, productivity-based and righteous (and now sadly, toxic) deflationary environment is again used as a reason for policy makers to come to the rescue.

As always, the headlines and group sentiment should prove valuable in helping to determine what course will be taken and when. Right now the herd is becoming ever more convinced the Fed is in control and staying the course. What do you think? 

© 2005 Gary Tanashian
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