The New Biggest Risk of All – DEFLATION

By Prieur du Plessis, on September 29th, 2008 posted in: Guest Bloggers, Investment, Markets, Money 4 people had their say - chime in!

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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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