The Coming Return Of Inflation
The most important reason for this was that money supply growth earlier this year had turned first stagnant and then directly negative. That had an immediate impact on the most flexible prices, which is to prices traded in financial markets, including stocks and commodities, although in those cases the global economic downturn had a significant impact as well as it causes corporate earnings and demand for commodities to decline.
Yet we are now likely starting to see the beginning of the end of this brief deflationary period. The reason for this is a reversal of the previous deflationary monetary trends. After reaching a low in the week to October 6, MZM has risen by a full 3.3% in the following 8 weeks, which translates into an annual rate of 23.5%. M2 has risen somewhat less, "only" 2.3%, yet that translates into 16%. And for those who prefer the extremely narrow M1 measure, that is up 5.1%, which translates into an annual rate of 38%. The monetary base is up 49.2% during this 8 week period, which in case you're wondering translates into an annual rate of 1246%. Bernanke hasn't just brought out the helicopters, he has brought out the B-2 bombers too, so to speak.
Because of the extremely high risk aversion, and deteriorating fundamentals for other assets, this massive onslaught of liquidity had at first simply the effect of brining down the effective Fed funds rate (now at just 0.14%, despite the fact that the official target is 1%) and Treasury yields, which at all maturities are trading at all time lows despite the massive increase in the supply of Treasuries due to the dramatic increase in the budget deficit. However, the recovery in stocks and commodities and the decline in the dollar in recent weeks could be a sign that the excess liquidity is spreading from the perceived safe havens to more risky assets, although it must be noted that the weak global economy will probably mean more setbacks for these assets. Still, with Treasury yields so ridiculously low, particularly at the short end (where they as I noted earlier had fallen to zero) certainly creates a climate conducive for alternative assets, despite weak fundamentals. And sooner or later, all the newly created money will spread to other assets and other parts of the economy, and bid up prices of more than just Treasuries.