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Bailout Bill Passed, What Happens Next, Inflation or Deflation?

Economics / Credit Crisis Bailouts Oct 03, 2008 - 05:20 PM GMT

By: Mike_Shedlock

Economics Best Financial Markets Analysis ArticleCongress passed a $700 billion bailout package today. It was a total and complete waste of $700 billion. It further depletes the pool of real funding.

Yes, the Fed has started a monetary printing campaign. Yes, the SEC will suspend mark to market accounting. So what happens now?

Pretending Is Not Reality

What happens now is that pretending does not alter reality. I can pretend all I want that Madame Merriweather's Mud Hut is worth $1 trillion and I can pretend my pet rock is worth the same. The reality (sorry Madame), is that neither is worth the book value I place on them.

Suspension of the mark to market rules will accomplish nothing but further mistrust of banks and bank stocks. Everyone will know banks are lying. No one will know by how much. What we still know is that Citigroup alone holds $1 trillion in off balance sheet SIVs.

Pretending those SIVs are worth $1 trillion will not make it so. Yes, $700 billion is a lot of money. But let's see just how fast it comes and let's see if all of it comes.

The countless $trillions in total bank assets that are not marked to market and will not be purchased by the Treasury, are realistically still going to see credit contraction (on a marked to market basis, and that is what counts).

Foolish Effort To Spur lending

Bernanke and Paulson think that the Fed buying toxic garbage will spur institutions to start lending. It won't. Banks will still be holding more garbage than the Fed can possibly buy. The market will be able to smell that garbage, even if the rules allow banks to pretend that garbage is a rose.

Banks have no reason to lend in a world of overcapacity, rising unemployment, and increasingly sour consumer attitudes. It was disingenuous at best to suggest this would free up lending for main street as it was packaged.

Rescue The Market?

All hopes were that action by Congress would "rescue the market". It can't and it won't. No jobs are being created by this bill, salaries are not going to rise, outsourcing is not going to stop, and foreclosures are going to rise.

If there was a $700 billion jobs package was passed instead of this monstrosity, especially if Davis-Bacon was scrapped like I wanted, tens of thousands of jobs would have been created and at least the US taxpayer would have gotten something for their money. Note: I am not arguing for $700 billion for jobs per se, I am merely pointing out that we would have at least gotten something out of it.

It was not to be. Stupidity won out as it usually does, but I am holding my head high for the effort that readers of this blog and others put in to kill this boondoggle.

Will Printing Lead To Hyperinflation?

Many have asked if the actions of the government would lead to hyperinflation. Others mockingly told me that it would. Nope. The answer is the same: Deflation.

There has never been hyperinflation in history with falling home prices. And home prices will continue to fall. Wasting $700 billion will not do the stock market any good either. The bottom is not in. Today's close proved it. There are new lows on the S&P 500, the Nasdaq, and the Dow.

Yes the Fed will print, but the money will sit, just as it did in Japan. Wasting $700 billion will only make things worse. Banks will still hoard cash.

Hyperinflation Dreams Are Way Down The Road

I am not the only one who has come to this conclusion. Please consider this audio with Austrian Economist Frank Shostak on Mises.

Shostak refers to Money AMS in the audio. An complete explanation of Money AMS can be found in Money Supply and Recessions .

A more recent update of Money AMS is in TMS: A Truer Money Supply? Unfortunately I cannot update that chart because a falling out with the person who created that chart for me.

Proper Definitions of Inflation and Deflation

Those who believe inflation is measured by the CPI, the PPI, or price increases of any kind desperately need to read Inflation: What the heck is it? , Interview with Paul Kasriel , and Deflation American Style .

The definition of inflation I am using is "A net increase in money supply and credit". Deflation is the opposite "A net decrease in money supply and credit".

Looking at deflation in terms of money supply (money that is actually lent) and credit (marked to market), the proper conclusion is the bailout bill does not change the picture, and that picture remains deflation.

I have said many times the fed can print but it cannot force banks to lend or consumers and businesses to borrow. We are about to find out who is right.

By Mike "Mish" Shedlock

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Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management . Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.

Visit Sitka Pacific's Account Management Page to learn more about wealth management and capital preservation strategies of Sitka Pacific.

I do weekly podcasts every Thursday on HoweStreet and a brief 7 minute segment on Saturday on CKNW AM 980 in Vancouver.

When not writing about stocks or the economy I spends a great deal of time on photography and in the garden. I have over 80 magazine and book cover credits. Some of my Wisconsin and gardening images can be seen at .

© 2008 Mike Shedlock, All Rights Reserved

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