Peter Schiff Replies to Mish's Deflation Rebuttal

Peter Schiff Replies to Mish's Deflation Rebuttal
http://globaleconomicanalysis.blogspot.com/2007/12/peter-sch...

In response to Not Your Father's Deflation: Rebuttal, Peter Schiff graciously responded in the comment section on my blog with the following three points:

1. I believe that eventually long-term interest rates will head much higher to reflect significantly higher inflation expectations, particularly here in the U.S. where a lack of domestic savings in the absence of willing foreign lenders will put even more upward pressure on rates.

My Counter: In long time frames I happen to agree. US rates will eventually head higher, just as Japanese rates will eventually head higher. The question is when and in what order. Long term rates in Japan fell to .25%. They can fall to that in the US. I am not saying will, I am saying can.

In shorter time frames there is an enormous pent up demand for US treasuries as treasuries are nearly universally despised domestically. Never before in history has everyone turned bearish right at a market top. Perhaps this is it. I doubt it.

However, let's assume Schiff is correct: Long term rates quickly start to rise because foreigners will not finance our debt. What would that do to default rates on housing, store expansion plans, hiring, wages, prices of homes, and prices of other assets? Unless and until consumer debt is wiped out, rising rates would massively increase default pressure as well as pressure asset prices.

2. Any credit the Fed provides will be spent. It is not necessary that the banks that originally borrow it loan it to Americans to buy houses or U.S. businesses to buy equipment. They can use it to buy oil, gold, wheat, foreign currencies or invest in foreign dividend paying stocks. As long as the Fed enables banks to borrow dollars below the rate of inflation, they will borrow all they can and invest the proceeds in appreciating or higher yielding assets. Then those dollars will be spent into circulation bidding up consumer prices.

My Counter: Citigroup (C), Morgan Stanly (MS), Merrill Lynch (MER), E*trade (ETFC), Ambac (ABK), MBIA (MBI), and Countrywide (CFC) are so capital impaired they all needed cash infusions, some from foreign companies, just to be able to continue operations.

Continued:
http://globaleconomicanalysis.blogspot.com/2007/12/peter-sch...

Strange Case of Falling International Reserves Explored
http://globaleconomicanalysis.blogspot.com/2008/11/strange-c...