10 October 2008

Is This a 'Deflationary Moment?'

In short, no.

This is what is called a short term liquidity crunch, where traders, in this case most likely hedge funds and small speculators, go into panic selling to address margin calls and short term cash obligations. It is the unwinding of leveraged positions under extreme short term duress. There is some talk that the CDS situation is causing this, and rumours that the banks are forcing the selling by raising short term margin and issuing margin calls, perhaps to an excess.

It is possible to turn this into a deflation, given time and a tightening of the money supply relative to economic growth. The word 'moment' is the tipoff here. There are no 'moments' in a real inflation or a real deflation. They are trends of weeks and months and sometimes years. Short term events, whether due to a storm, the collapse of a company, a panic, are just that: events.

What we are seeing today, almost across the board, is hedge funds selling almost everything to raise cash to meet their obligations. We suspect that the Lehman CDS settlement today may be a precipitant. We are also seeing banks continuing to tighten their lending even to the funds.

It will reach a climax and then things will begin to normalize. VIX is at crash levels today.

For this to become a true 'deflation' would require the world's central banks to start tightening credit, raising interest rates, tightening government budgets. Lets see if they do that. Merely doing nothing would probably not even be enough, since the market would just find a level at which it could clear and then normalize. It takes serious government meddling to create problems like a hyperinflation or a true deflation.

Its important to keep these things square in our minds. Cooler heads prevail, given a little time, and panicking is never a wise strategy, unless you panic first. We're probably beyond that point..

Gold Falls as Dollar Gains, Investors Sell Metal to Raise Cash
By Pham-Duy Nguyen
October 10, 2008 13:09 EDT

Oct. 10 (Bloomberg) -- Gold tumbled from the highest since July as the dollar strengthened and investors sold the metal to cover losses in equity markets. Silver plunged 11 percent.

The dollar headed for the second consecutive weekly gain against a weighted basket of six major currencies. Earlier, gold reached $936.30 an ounce, the highest since July 29, on demand for a haven amid plunging global equity markets.

``Investors are selling gold to raise dollars,'' said Frank McGhee, the head dealer at Integrated Brokerage Services LLC in Chicago. ``It's fear versus dollar strength, and dollar strength is winning...''