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The Millenium Wave

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Rapid innovation will lead us out of the crisis.

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While the stock market may enjoy a serious rally over the next few months, we're not out of the woods. The fire is still raging and we are witnessing ever-more aggressive attempts to get the fire of the credit and housing crisis under control.

Yesterday the Treasury announced yet another huge $800 billion bailout, but this one has a different flavor. Much of the previous bailout money has come from the Treasury either borrowing money and buying assets (which doesn't create new dollars) or simply taking assets onto the national balance sheet, guaranteeing the debt. With this latest move, the Fed is going to buy $600 billion in mortgage bonds by monetizing, or creating, new dollars.

Normally this would set off more alarm bells over inflation. But these aren't normal times. With the twin bubbles of the credit and housing crises still imploding, we are seeing a massive deleveraging and the disappearance of multiple trillions of dollars from consumers and businesses. And the bond market clearly expects more softening and maybe even deflation. The 10-year bond is below 3%.

The velocity of money (how fast a dollar moves through the economy) is slowing rather dramatically. It could fall another 10% and just get back to the average for the last 107 years. Given the growth in population, inflation, productivity and other factors, the money supply will need to grow by 7% annually for the next several years to keep the economy at equilibrium. Remember, GDP is essentially the velocity of money times the supply of money. If the velocity slows down, the money supply needs to rise to stay even.

The Fed is going to have some room to pump up the money supply without seeing inflation rise precipitously. I think this is the first of what will be several large injections. They will especially do more if it looks like we could roll over into a deflationary environment next year.

The Millennium Wave

Over the next 10 to 12 years, we will see 3 recessions that will slowly move the average price-to-earnings ratio of stocks to historic lows. Rising oil and energy prices will be a main culprit of both the slowdown in the economy and an increase in inflation. Ever-increasing monetary inflation will, in fact, trigger a huge increase in all commodity prices, as well as a decline in bonds. Asset inflation will show up in the housing markets as home values continue to skyrocket.

The dollar will continue to weaken against major foreign currencies. The current war will become increasingly unpopular, and the next administration will be forced to withdraw troops, under the guise of declaring victory. The American voting public will be split as never before, with major patterns in voting habits making a generational change. The newspapers will continue to write about how an Asian country will dominate the world economically in less than a few decades.
No positions in stocks mentioned.

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