Monday October 31, 2005 - 12:25:14 GMT
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Black Swan Capital - www.blackswantrading.com
“The implementation of a policy of stabilizing prices will lead to an overproduction of some goods and underproduction of some other goods. This is, however, not what the stabilizers like Bernanke are telling us. They believe that the greatest merit of stabilizing changes in the price level is that it allows free and transparent fluctuations in relative prices, which in turn leads to the efficient allocation of scarce resources.
“Since it is not possible to isolate the monetary effect on individual prices of goods, obviously the whole idea that one can measure and somehow stabilize the price level is preposterous. If anything such a policy runs the risk of tampering with the free movement of relative prices, which leads to instability and the weakening of the process of wealth generation.
“Furthermore, the biggest problem with Bernanke's perspective is that it regards increases in prices rather than the expansion in the money supply as inflation. By focusing on the symptoms rather than causes, there is no way that one can make an economy more healthy and prosperous.”
Frank Shostak, Mises Institute
On one end of the spectrum, we have the US slowdown crowd—2% GDP growth by mid-2006. They say Fed rate hikes are starting to bite. Higher energy prices have taken a toll on Mr. Consumer; he is nearing a tipping point, especially as housing starts to cool. By the first quarter of next year, the Fed will be thinking about cutting rates to salvage sagging demand. Falling energy prices will quickly change the dynamics of inflation. Buy bonds, sell stocks.
Then there’s the growth/inflation camp that says the US consumer is fine. Jobs and income are rebounding. There is still too much liquidity in the system and we now have a real inflation problem on our hands. Therefore the Fed will surprise the market with its aggressive action and language going forward. This camp is squarely behind San Francisco Fed President Janet Yellen, who says the elusive “neutral rate” could be somewhere near 5.5%. Buy stocks, sell bonds.
Quite possibly the chart below captures these competing sentiments. There is a growing divergence between top-tier financial stocks and Treasury bond prices. The daily chart compares Citigroup to US 10-yr T-note futures…
We unfortunately find ourselves straddling both camps. As you know, we think energy prices will surprise lower. We also believe it likely newly appointed Fed Chairman Bernanke will tack on a hike or two to the Maestro’s last move, as he grasps the inflation-fighting baton, proving he’s not just a pretty face—he can fight inflation too.
When we couple our “straddle view” to our belief the European Central Bank will prove more talk than action (i.e. growth risk trumps inflation risk), we remain firmly dollar bullish as the attractiveness of US yields continue to grow.
Black Swan Capital
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