Former Federal Reserve Chairman Alan Greenspan said he’s worried that lawmakers will hamper U.S. central bank efforts to rein in its monetary stimulus, and that inflation might “swamp” the bond market.

“It’s the politics in the United States that worries me, whether the Congress will basically feel comfortable” with the Fed withdrawing its stimulus, Greenspan said in a broadcast to Tokyo clients of Deutsche Bank Securities Inc. today. He later said that “if inflation rears its head, it will swamp long-term markets,” referring to bonds.

With U.S. unemployment running at a quarter-century high, the Fed may face resistance from lawmakers as it tries to promote price stability by raising its benchmark interest rate from near zero. The jobless rate reached 9.7 percent last month and employers have cut almost 7 million jobs, the biggest drop in any recession since World War II.

The former Fed chief, who counts Deutsche Bank among his clients, also warned that the U.S. must rein in its “very dangerous” level of debt, citing the threat of increased issuance of Treasuries undermining the dollar.....

If only the moderator had called on me, I might have gotten an answer to my questions and left with more confidence in the Federal Reserve’s ability to pull off its exit strategy without a hitch.

Speaking at a conference in Washington last week sponsored by the Cato Institute and Shadow Open Market Committee, a group of self-appointed Fed watchers, Fed Vice Chairman Don Kohn reiterated the conditions and tools for withdrawing excess liquidity already outlined by Fed chief Ben Bernanke.

The tools include raising the interest rate the Fed pays on reserve balances to put a floor under short-term rates; draining reserves via outright sales of securities or reverse repurchase agreements; and allowing loans made under the Fed’s “unusual and exigent circumstances” authority to wind down, paring the central bank’s balance sheet through natural attrition.....

Confused about what the future holds for the economy? So are financial markets.

Record gold prices and negative US Treasury yields are strange bedfellows, indicating general uneasiness but also conflicting bets on inflation or deflation.

As the great economist Woody Allen once put it: “More than any other time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness, the other to total extinction. Let us pray we have the wisdom to choose correctly.”

Fear that one’s net worth might evaporate is, of course, no laughing matter. In spite of the fact that risk appetite has come roaring back, it is hard to reconcile resurgent optimism with the eventual fiscal and monetary hangover of the financial crisis.

Voices from beyond Wall Street who foresaw the debacle now range from mildly to wildly pessimistic. Nobody captures the confusion better than the satirical economic country and western singer Merle Hazard (geddit?) crooning about whether we face hyperinflation or deflation: “Will we become Zimbabwe or will we be Japan?”

Unprecedented growth in money supply will unleash higher inflation warns Bob Wiedemer, co-author of the recently published Aftershock, and of the prescient 2006 book America’s Bubble Economy......

NEW YORK (MarketWatch) -- An investment letter that called the Crash of 2008 said that this would be a bad year -- and it now says it will get worse.

A whole generation of investors think that Robert Prechter and his Elliott Wave Theory letters, Elliott Wave Financial Forecasts and Elliott Wave Theorist, are permabears. And they've certainly seemed that way for the last decade -- although it should be noted that the stock market is now roughly back where it started. ( See April 26, 2002 column. )

But Prechter was very bullish after the 1974 low and, briefly, after being one of the very few services to make money in 2008. Then he announced that "2010 is the year when the bear market in stocks returns in full force." ( See Jan. 22 column. )

Elliott Wave Financial Forecasts (EWFF) makes recommendations specific enough to be tracked by the Hulbert Financial Digest. (The Elliott Wave Theorist is too, well, theoretical.)

Over the year to date, EWFF is up just 0.4% by Hulbert Financial Digest count through May vs. negative 0.3% for the dividend-reinvested Wilshire 5000 Total Stock Market Index.

Over the past 12 months, its bearishness did cause it to gain just 4.75% compared to 22.89% for the total return Wilshire 5000. But over the past three years, the letter's bearishness paid off handsomely. It's up an annualized 5.25% against negative 8.12% annualized for the total return Wilshire 5000.

And even over the past 10 years, so badly damaged have stocks been that the letter was up an annualized 1.05%, outperforming a mere 0.22% annualized gain for the Wilshire 5000.

The EWFF issue published in early May said flatly: "The topping process is over for the countertrend rally that started in the first quarter of 2009. The next leg lower that commenced in April should now deliver a decline that will ultimately be bigger than the 2007-2009 sell-off. ... Gold poked to a new high, but in doing so, likely completed a pattern in mid-May that will lead to a multi-month selloff. ... The U.S. dollar index (DXY 85.56, -0.12, -0.15%) is fulfilling EWFF's forecast for a strong advance."

All of which fits right into Prechter's repeated predictions of a massive coming deflation.....

The jury is out: I have been in the deflation camp personally for the last 2 years, but I hear the arguments for Zimbabwean hyperinflation, or the case of the oscillation in no man's land as governments and central banks stop us on our way to the deflationary Kondratieff winter at each market collapse with a new round of monetization. Maybe this last cynic remake of the Japanese lost decades is the most obvious way to bet on the demagogy of our modern "capitalist" system where government are helpless against deflation and will therefore sacrifice our future and the planet if they have to in order to save whatever face they have left.

Either way, which ever case you are leaning towards, it is important to find indicators that will tell you what the market is leaning towards, as ultimately it is the only way t make money if you don't have the capital or luxury to hold out your positions through monkey reversals like we saw today.

I will start with the inflationary case. If today's move has legs and we are going to get an established weakening of the USD trend along with higher commodities, equities, and raging emerging markets, then the two following patterns will be triggered: Inverted H&S in Copper (neckline currently around 308) and inverted H&S in Bovespa (neckline currently around 65,500 which also corresponds to the 100-dma and 200-dma which just posted a bearish cross). Given my bias I will be looking at shorting the Bovespa around that are because of the moving average pattern and the strong resistance. However if both patterns are validated then clearly the market could have serious legs as there will be shorts to squeeze and fake break outs is a privilege reserved to shorts......

U.S. Treasuries fail to provide safety or liquidity when it comes to managing China’s $2.45 trillion foreign-exchange reserves, said Yu Yongding, a former central bank adviser.

“I do not think U.S. Treasuries are safe in the medium-and long-run,” Yu, a member of the state-backed Chinese Academy of Social Sciences, wrote yesterday in an e-mailed response to questions. China is unable to sell the securities in a “big way” and a “scary trajectory” of budget deficits and a growing supply of U.S. dollars put their value at risk, he said.

The State Administration of Foreign Exchange, which manages the nation’s reserves, said last month that U.S. government debt has the benefits of “relatively good” safety, liquidity, low trading costs and market capacity. China’s holdings of Treasuries, the largest outside of the U.S., totaled $867.7 billion at the end of May, down from $900.2 billion in April and a record $939.9 billion in July 2009.

To help cool demand for the securities, China needs to curb the growth of its foreign reserves by intervening less in the currency market, Yu said. The People’s Bank of China said June 19 it would let the yuan float with reference to a basket of currencies, ending a two-year-old dollar peg.

The yuan has since appreciated 0.8 percent to 6.773 per dollar and analysts surveyed by Bloomberg predict the currency will end the year at 6.67, based on the median estimate. China limits appreciation by buying dollars, fueling its demand for Treasuries......

Based on the comments and emails I'm receiving lately, it appears more and more people are hopping on the deflation bandwagon. These correspondences have exposed to me an obvious misunderstanding of basic facts. While I suppose I am an "inflationist", I'm the first to admit that deflationists have some valid arguments to support their claims. But at the end of the day, their arguments are flawed; I just don't see deflation as a realistic threat moving forward.

There is a constant tug of war between deflation and inflation that hinges on factors such as money supply, credit, interest rates, and inflation expectations. While these variables push inflation in either direction, there is undoubtedly one variable that swings the odds decisively in either direction, and that is the dollar. There can be no sustainable deflationary trend with a falling dollar any more than there can be an inflationary trend with a rising dollar.

So let's get one thing out of the way. Deflationists are saying that the dollar will rise in value, and based on some of the doomsday asset collapse projections I'm hearing, quite dramatically. Now if this isn't already ridiculous to you, I'll examine some of the factors that will make a sustainable rise in the dollar unlikely. To do this, we must explore the last great deflationary period in the U.S, the Great Depression.

Most people think of the Great Depression as one continuous deflationary collapse- but it wasn't. Broadly speaking, we can break down the Great Depression into 3 stages: 1929-1932, 1933-1937, and 1938-1941. The key period is 1933-1937, for this is when we saw the initial inflationary effects of going off the gold standard.

Below I will present some things to take away from the Great Depression. These factors are critical to understanding why a deflationary collapse is unlikely to occur based on present-day conditions......

Right now, we are in the middle of deflation. The Global Depression we are experiencing has squeezed both aggregate demand levels and aggregate asset prices as never before. Since the credit crunch of September 2008, the U.S. and world economies have been slowly circling the deflationary drain.

To counter this, the U.S. government has been running massive deficits, as it seeks to prop up aggregate demand levels by way of fiscal “stimulus” spending—the classic Keynesian move, the same old prescription since donkey’s ears.

But the stimulus, apart from being slow and inefficient, has simply not been enough to offset the fall in consumer spending.

For its part, the Federal Reserve has been busy propping up all assets—including Treasuries—by way of “quantitative easing”.

The Fed is terrified of the U.S. economy falling into a deflationary death-spiral: Lack of liquidity, leading to lower prices, leading to unemployment, leading to lower consumption, leading to still lower prices, the entire economy grinding down to a halt. So the Fed has bought up assets of all kinds, in order to inject liquidity into the system, and bouy asset price levels so as to prevent this deflationary deep-freeze—and will continue to do so. After all, when your only tool is a hammer, every problem looks like a nail.

But this Fed policy—call it “money-printing”, call it “liquidity injections”, call it “asset price stabilization”—has been overwhelmed by the credit contraction. Just as the Federal government has been unable to fill in the fall in aggregate demand by way of stimulus, the Fed has expanded its balance sheet from some $900 billion in the Fall of ’08, to about $2.3 trillion today—but that additional $1.4 trillion has been no match for the loss of credit. At best, the Fed has been able to alleviate the worst effects of the deflation—it certainly has not turned the deflationary environment into anything resembling inflation.

Yields are low, unemployment up, CPI numbers are down (and under some metrics, negative)—in short, everything screams “deflation”.

Therefore, the notion of talking about hyperinflation now, in this current macro-economic environment, would seem . . . well . . . crazy. Right?

Wrong: I would argue that the next step down in this world-historical Global Depression which we are experiencing will be hyperinflation......

I usually don’t do follow-up pieces to any of my posts. But my recent longish piece, describing how hyperinflation might happen in the United States, clearly struck a nerve.

It was a long, boring, snowy piece of macro-economic policy speculation, discussing Treasury yields, Federal Reserve Board monetary reaction, and the difference between inflation and hyperinflation—but considering the traffic it generated, I might as well been discussing relative breast size in the porn industry. With pictures.

Essentially, I argued that Treasury bonds are the New and Improved Toxic Assets. I argued that, if there was a run on Treasuries, the Federal Reserve—in its anti-deflationary zeal, and its efforts to prop up bond market prices—would over-react, and set off a run on commodities. This, I argued, would trigger hyperinflation.

The disproportionate attention my post garnered is indicative of people’s current fears. As I’ve said before, people aren’t blind or stupid, even if they often act that way. People are worried—they’re worried about the current state of affairs: Massive quantitative easing, toxic assets replaced by the full faith and credit of the U.S. government in the shape of Treasuries, fiscal debt which cannot possibly be repaid, a second leg down in the Global Depression that seems endless and only getting worse—people are scared. Many readers gave me quite a bit of useful feedback, critiques, suggestions and comments on the piece—clearly, what I was discussing touched on a deeply felt concern.

However, there were two issues that many readers had a hard time wrapping their minds around, with regards to a hyperinflationary event:

The first was, Where does all the money come from, for hyperinflation to happen? The question wasn’t put as baldly as that—it was wrapped up in sophisticated discussions about M1, M2 and M3 money supply, as well as clever talk about the velocity of money—the acceleration of money—the anti-lock brakes on money. There were even equations thrown around, for good measure.

But stripped of all the high-falutin’ language, the question was, “Where’s all the dough gonna come from?” After all, as we know from our history books, hyperinflation involves people hoisting bundles and bundles of high-denomination bills which aren’t worth a damn, and tossing them into the chimney—’cause the bundles of cash are cheaper than firewood. If the dollar were to crash, where would all these bundles of $100 bills come from?

The second question was, Why will commodities rise, while equities, real estate and other assets fall? In other words, if there is an old fashioned run on a currency—in this case, the dollar, the world’s reserve currency—why would people get out of the dollar into commodities only, rather than into equities and real estate and other assets?

In this post, I’m going to address both of these issues.....

Bill Gross’s Pacific Investment Management Co. made an $8.1 billion wager that the U.S. won’t suffer a decade of deflation like the one that crippled Japan starting in the 1990s.

That’s the notional value of long-term derivative contracts tied to the U.S. consumer price index that Pimco’s mutual funds entered into during the first half of this year, according to a regulatory filing. The funds received $70.5 million in up-front premiums under these contracts, known as inflation floors, in return for agreeing to pay investors should prices decline in the 10 years ending in 2020.

“We think the possibility that the U.S. goes 10 years with stagnant or falling prices is remote,” Mihir Worah, the head of Pimco’s real return portfolio management team, said in an e- mailed response to questions. “The options were priced at rich levels to the underlying” risk, added Worah, whose funds invest in Treasury inflation protected securities.

The cost of protecting against deflation has doubled since January as signs of an economic slowdown in the U.S. prompted investors including Canadian insurer Fairfax Financial Holdings Ltd. to buy the derivatives. James Bullard, president of the Federal Reserve Bank of St. Louis, said the U.S. could suffer the same type of economic malaise as Japan. Pimco Chief Executive Officer Mohamed El-Erian said last month the chance of deflation in the U.S. is around 25 percent.....

The Federal Reserve’s statement yesterday that inflation is below levels consistent with the central bank’s mandate for price stability means it’s time to buy gold, said Allen Sinai, chief global economist at Decision Economics Inc. in New York.

“That’s code for we don’t want to go the way of Japan so we’re going to print money,” Sinai said in a radio interview today on “Bloomberg Surveillance” with Tom Keene. “You gotta buy gold when those two central banks are doing what they’re doing.”

Gold for December delivery was 1.6 percent higher at $1,294.2 an ounce at 8:11 a.m. on the Comex in New York, after touching an all-time high $1,296.50. Bullion for immediate- delivery rose 0.4 percent to $1,292.60 an ounce in London, after earlier today rising to a record $1,295.

The Fed’s Open Market Committee said yesterday it was “prepared to provide additional accommodation if needed” to support the recovery and boost inflation. Gold, which often moves counter to the dollar, has advanced 17 percent this year and is heading for its tenth consecutive annual gain.

Sinai said he forecasts a $1,500 price for gold. “Inflation adjusted it’s still cheap as odd as it sounds,” he said.

.....The Inflationary Consequences of John Maynard Keynes

Inflation is always and everywhere a monetary phenomenon, according to Milton Friedman, who has been eclipsed in recent years by his chief competitor, John Maynard Keynes. Every bond investor suspects that chucking billions of dollars into the global economy builds a bed of kindling; nobody wants to shout “fire!” in a crowded trade.

The Answer to Too Much Debt Is Not More Debt

Lending to governments is not risk-free, whether that government is Argentina, Iceland, Ireland or the U.S. These days, when you buy government debt, you are taking on the credit risk of the global financial system because that is what the too-big-to-fail doctrine has saddled the world’s taxpayers with.

This week’s successful debt auctions by Ireland, Greece and Spain sure beat the alternative of failed sales with nobody turning up. With central banks acting as buyers of first and last resort, however, it is impossible to pretend that the capital markets are functioning properly -- another dirty little secret kept suppressed deep in the subconscious.

Are Japan's recent QE moves any indication?

Inflation-protected securities sold at negative yields for the first time ever on Monday as traders anticipate that the Federal Reserve will start a new round of asset purchases.

Analysts said that asset purchases by the Fed would lead to a higher inflation rate and a positive return on the bonds.

The $10 billion auction of the five-year bonds sold at a negative yield of 0.550 percent, according to the Treasury Department. The results of the auction of the securities, known as TIPS, came as indexes on Wall Street edged higher, buoyed by recent strong corporate earnings and a rise in housing sales. The previous lowest yield for the TIPS was in the auction on April 26, when the yield was 0.550 percent.

“It is saying that there is a true demand for inflation securities, because people perceive the quantitative easing program is enabling a higher inflation rate in the future,” said Tom di Galoma, head of fixed-income rates trading at Guggenheim Partners.....

The bond market is showing Federal Reserve Chairman Ben S. Bernanke will succeed in sparking inflation after the smallest gain in core consumer prices in half a century increased concerns that the economy will deflate.....

Inflation? No, thank you.

We just endured and survived a major political crisis over the possibility that the U.S. government might default on its debts. Most people -- other than a few high-stakes poker players on the right wing of the Republican Party -- agreed that this would be a terrible thing. But now, a growing number of voices, mainly on the left wing of the Democratic Party but also in the Federal Reserve, are calling for what is in effect default in slow motion. It goes by the name of inflation.....

^ yes, but all it takes is for the Chinese and Japanese to skip a couple of T-Bill/Bond auctions and things will change dramatically. Those two countries are the biggest purchasers of U.S. debt and things will change if they stop buying notes from us. All the smaller country purchases will follow suit in quick order and then see what happens to the almighty dollar- it will make a Peso look good.

I actually hope the prediction doesn't come true, but you can not ignore what's happening with gold and silver. My last Silver dollar order bought Eagles for $17.93 on 9/4- these are now $19.42 on 9/16. That's an 8.3% gain and I haven't even received the order yet. To be fair, the SP500 is up about 5% during the time frame. Commodities prices are accellerating because of the fear of inflation.

There was a book called 'Bankruptcy 1995' that predicted bad stuff happening in 1995- obviously that was a little early. Nothing has fundamentally changed since that book was written- except the interest rates got amazingly low and temporarily stopped things.

We still have ever-growing deficits and little if anything has been done to resolve the deficits. The U.S. talks a good talk about cutting spending but nothing actually happens. You think two years is too early, but I could counter that this event is actually about 9 years too late based on models set forth in that book. I wish I still had that book but my Wife through it out after 2000 thinking it was outdated.