The New Biggest Risk of All – DEFLATION

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This post is a guest contribution by Bennet Sedacca*, President of Atlantic Advisors Asset Management

Welcome back, my friends, to the show that never ends.
We’re so glad you could attend.
Come inside! Come inside!
There, behind a glass, is a real blade of grass,
be careful as you pass.
Move along! Move along!

Cold and misty morning, I heard a warning borne in the air
About an age of power where no one had an hour to spare,
Where the seeds have withered,
silent children shivered, in the cold.
Now their faces captured in the lenses of the jackals for gold.

Karn Evil 9, Emerson, Lake and Palmer (from the album Brain Salad Surgery)

My Biggest Fear
Without question, my biggest fear since the Credit Crisis began, even while watching the events that led up to it—the absurd levels of debt on every front, the creation of esoteric instruments based on bad debt—has been what would happen once the Credit Crisis unfolded. That fear was deflation; something that I sense is now upon us. You may not be familiar with deflation since it hasn’t been seen in this country since the 1930’s. So in case you are not familiar, I have provided a definition below. I believe the deflation situation that we are facing today in our nation is clearly defined by Investopedia:

Deflation: A general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending. The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression.

So how do we deal with deflation?
From the Federal Reserve’s website, their four main goals are outlined below:

• Conducting the nation’s monetary policy by influencing money and credit conditions in the economy in pursuit of full employment and stable prices.

• Supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers. .

• Maintaining the stability of the financial system and containing systemic risk that may arise in financial markets.

• Providing certain financial services to the U.S. government, to the public, to financial institutions, and to foreign official institutions, including playing a major role in operating the nation’s payments systems.

From the European Central Banks website, their primary goal is outlined below:

• The primary objective of the ECB’s monetary policy is to maintain price stability. The ECB aims at inflation rates of below, but close to, 2% over the medium term.

So there we have it. The Fed and ECB’s goal is to ensure a safe system with price stability. Nowhere in either of the Central Bank statements does it say that a goal should be to avoid price and asset erosion.

This is my greatest fear of all and one that is playing out in real time. In sum, I believe that deflation is either already upon us or is right around the corner. And from my perch, deflation is a far worse outcome than inflation in that inflation can be contained while deflation is not easily contained. Just ask the Japanese.

Click here for Bennet’s full report.

* President of Atlantic Advisors Asset Management, Bennet Sedacca brings with him more than 26 years of securities industry experience. From 1981 to 1997 he worked for several major investment banks, specializing in high-grade fixed-income securities marketing, trading and portfolio management. While working for PaineWebber as a Senior Vice- president, Bennet was a member of the Chairman’s Council for four consecutive years. During his years with Salomon Smith Barney as a Vice-president, he established an institutional fixed income presence in Central Florida.


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4 comments to The New Biggest Risk of All – DEFLATION

  • Interesting perspective on deflation. I would think that this would be very possible, given the ULTIMATE decision regarding the bailout. As I’ve always been on the side of hyperinflation if this does occur. The question is how much money is required to simply add stability to the market so that it can rebound on its own, without overpowering government intervention. Has everyone also forgotten that our trade deficit is nearing $7 Trillion .

  • Frustration and anger are two feelings that come bubbling forth from my gut as I watch the drama unfold in regard to the rescue plan for our financial system being deliberated before my eyes. At the heart of the matter sit the two Government Sponsored Enterprises (GSE’s) Fannie Mae and Freddie Mac. The utter disregard for the facts by the mainstream television and print media, Barney Frank and Christopher Dodd completely amazes me.

    The implicit guarantee of government backing for mortgage securities peddled by the two GSE’s, as they operated under the guise of “providing affordable housing”, gave them the ability to enjoy lower interest rates on their bonds, which in turn allowed them to prevail over private companies providing mortgage backed securities. The increased leverage, lack of competition and tacit approval of their operations by politicians receiving campaign contributions through their lobbying efforts allowed their CEO, Franklin Raines, to earn over 100 million dollars, before being ousted for accounting irregularities. Now Frank and Dodd are trying to position themselves as champions of Main Street, while the financial system grinds to a halt. For a more in depth analysis of the Fannie & Freddie debacle, see the articles in the Wall Street Journal and Investors Business Daily from Tuesday, September 23, 2008.

    Ben Bernancke was elevated to Federal Reserve Chairman because he was respected for his knowledge and credentials. Hank Paulson was called upon to be Treasury Secretary because of his knowledge of the financial markets. If they are this concerned about the current crisis in our financial system, I think we better stop with the politics and soberly address the situation. This is NOT a bailout of Wall Street, but rather a rescue of our financial system. If the stock market is halved again in this decade, the pain on Main Street will be devastating. We all enjoyed the rising equity in real estate from 2002 through 2006, but the sad reality is much of it was based on smoke and mirrors. Perhaps this will usher in an era of building wealth methodically through investing, rather than the get rich quick schemes of day trading, real estate flipping and other fads which have led to bubbles and busts. One could only hope!

    John H. Kaighn

    Jersey Benefits Advisors

    The Kaighn Report

  • […] The New Biggest Risk of All – DEFLATION – “It seems like a foregone conclusion that deflationary pressures are now squarely upon us. Prices are falling in asset classes across the board,” said guest contributor Bennet Sedaca.  – Investment Postcards from Cape Town  […]

  • Deflation pretty easy to get there. Systemic risk averted.

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