By Eric Roseman
The federal government is now on course to engineer the greatest expansion of credit in history. The long-term consequences will ultimately be disastrous for American financial assets, particularly the dollar and Treasury debt.
Thus far in September the Fed has expanded its balance-sheet by some US$425 billion dollars. In just the past three weeks, the Fed has rescued Fannie (FNM), Freddie (FRE), and AIG (NYSE:AIG), spent tens of billions of dollars in efforts with other central banks and has extended a US$75 billion dollar lifeline guarantee to money-market fund investors.
But these figures pale in comparison to the estimated cost of Paulson's new plan.
Clearly, the credit crisis requires desperate measures and only governments can help to alleviate or even quash systemic failure through unprecedented credit expansion. Like I've said all along, it's Inflate or Die for Western capitalism.
The strains of deflation, however, will take time to extinguish. Markets are wrong to think we can all enjoy a sustained v-shaped recovery. This just won't happen. Corporate profits will decline for at least the next two quarters.
But over the next 18-36 months, inflation is going to make a formidable comeback as the chickens come home to roost in the United States and Europe.
The cost to resuscitate the financial system is primarily an American problem and will result in a massive expansion of credit. So inflation is all but inevitable.
The best long-term short-sale in my book is Treasury debt. The dollar will eventually return to the basement but that might be delayed as the outlook in Europe grows more and more dim. Though I can't make a long-term case for the dollar, the odds are high that it can continue to rally over the next several months or more, especially if RTC II is passed.
Next on the chopping block for the bears is the Treasury market. The United States will have to pay its creditors higher interest rates in the future. U.S. funding costs will eventually rise significantly unless the United States cuts its bloated spending. And the odds of that happening are pretty much nil.