Random Thoughts: A Top-Down View of the World

"What’s clear is that the game itself has experienced a seismic shift. Central banks have been extremely proactive in what they do and how they do it. This has been going on for years but the efforts increased appreciably since last summer. We opined at the time that something was afoot and the pieces have seemingly fallen in place.

"We are approaching a critical crossroads; structural imbalances have cumulatively increased since the back of the tech bubble and risk has built to a crescendo. The credit contagion simply served as a catalyst to bring this conundrum to bear. All that remains to be seen is where the bear will domicile.

"Let’s look at both sides of the great debate. To the left is the socialization of markets, nationalization by governments, and the potential for hyper-inflation. To the right, we have asset class deflation, risk aversion and the unwinding of the debt bubble.

"If the Northern Rock nationalization is the first in series of similar steps, we could conceivably see the stateside assumption of mortgage debt by the US government. This would hit the dollar and spike equities, at least until interest rates rose to levels deemed attractive as an alternative investment.

"That is the hyperinflation scenario, one that is presumably preferred by the powers that be as an alternative to watershed deflation. The 'haves' would fare better than 'have nots,' which would include the former middle class that suffers as a result of moral hazard, as the costs of goods and services skyrocket.

"The other scenario is the draining of liquidity from the system, which would ignite the fuse for a higher greenback as currency becomes scarcer. Asset classes across the board, from commodities to equities, would deflate and impact the top tier of our societal structure that is tied to the marketplace.

"That, quite obviously, would be problematic for policymakers and the constituencies that bankroll them. Deflation in a fractional reserve banking system means that they have, for all intents and purposes, lost control of the economy. It is an admission of defeat, albeit one that may be unavoidable."