Timmothy Posey's  Instablog

It has been said again and again that the only way out of debt is to inflate the overall economy in such a way that the consumers who are the possessors of such debt will be able to pay their way out with inflated dollars. That so far has been the Bernanke Playbook since Day 1. Many of my fellow colleagues have been pointing towards coming stagflation, an environment marked by rising prices, most notably consumer input prices in the form of gasoline costs, mortgage rates. The flip side to the stagflation coin is a stagnant economy, once thought impossible with inflation, in the form of rising unemployment, rising government debt, and of course lower GDP output.

The main difference we expect between 70s-style Stagflation versus our "Benflation" is that we will see some economic growth, albeit at a much slower form than we have been used to. How did we get here? We can easily review the game plan that the Fed Chief himself has gone by.

"[T]he U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation. "

The problem is that the gov't has now kicked the printing plans into overdrive in a desperate attempt to force more dollars down to consumers to generate more spending. Although this blog has the utmost respect for the academic and professional credentials of our Federal Reserve Chairman, there will be side effects to these plans. The most notable characteristics of the coming "Benflation" will be two major differences in our growth from the past decade.

$6 a gallon for gas: The chart below shows very simple technical analysis based on the price action of gasoline for the past 30 years (I'll be happy to accept credit for the first person in the known universe to perform technical analysis on gasoline prices, but, I digress). We see the red lines serve as both resistance and then support going forward with retracements of roughtly 25%, 35%, and we last saw a 60% increase from the past bounce out of support this past summer. What does that mean for us? Interpolating a guestimate value of about 30-35% increase off of resistance from last summer's all time high of $4.40, it is in our predictions that $6 gasoline fits within the historical norms of past price behavior, not to mention with deflated dollars and printing presses running 24/7.

Return of the 8% Mortgage Rate: This blog has made loud noises in the past in regards to the 10-yr Treasury Bond Yield blowing out to higher yields which will result in higher borrowing costs for consumers, and mortgage-like debt. Our updated chart with last week's price action only proves our theory further that the 10-yr yield is going higher than the 5.25% previous high. With an average spread of about 2.5% for a mortgage on top of the 10-yr rate, 8% is not out of the question, and very likely, especially if the inflation that Ben wishes for actually trickles down to the consumer. The problem is now that if the Fed chooses to buy more Treasuries, it runs the very severe and real risk that the bond market will continue to sell of Treasuries (increasing the yields) because of the expectation of higher inflation. Thus the cycle continues.

The current concern of this blog is the speed at which the Fed is wishing to push down this inflation. Because of the velocity in which the monetization of debt has occurred ($1.25 trillion in a matter of months), along with over $12 trillion (actually, we stopped counting back in February) in "fiscal stimulus" from various government programs in the past 18 months it is our fundamental belief that the coming cost in the form of higher borrowing costs and commodities will be right around the corner (within 18 months). With an upcoming Fed meeting next week, we may see even more acceleration of this monetizing of debt (read: turning outstanding debt into paper currency).

Full Disclosure: Overweight energy products via DBE and USL. Short SPY Calls going into June expiration.