“…Now, as I said already, during the years 1924-27 and 1928 we experienced an unprecedented growth of the volume of production. Commodity prices, as measured by the wholesale price index, were fairly stable… From this it follows, and direct statistical investigations have verified it, that the volume of the circulating medium had been increased. We could say, there was a “relative inflation,” that is, an expansion of means of payment, which did not result in an increase of commodity prices…There is now an obvious presumption that it was precisely this relative inflation which brought about all the trouble. If this were so-and it seems to me that it is very probable-it would be plain that the price level is a misleading guide for monetary policy and that there are monetary influences at work on the economic system that do not find an adequate expression in a change of the price level, at least as measured by the wholesale price index…” Gottfried Haberler, “Money and the Business Cycle”, 1932

Good morning. I could start my comments regurgitating the main widespread news:

- Goldman Sachs issuing $5BN of shares to repay TARP (Do you think this announcement and the S&P500 reaching beyond 850 pts is mere coincidence?)
- The Fed’s heavy purchase yesterday of $5.15BN in Agency debt (Agency debt is a security issued by a U.S. government-sponsored agency, i.e.  Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac))
-The Canadian dollar appreciating to below 1.22 CAD/USD, in spite of oil at $49 and the perception that the Bank of Canada will engage in quantitative easing
-The increasing share and debt buybacks or debt exchanges (I will write on the true significance of this, in upcoming letters)
-The omniscient and omnipresent signs of weakness in every possible economic indicator
-Equity markets and Treasuries still higher (Fed buying $7.4 billion of 2-yrs to 3-yrs), which although with low volumes, was positive for risk. At the end of the session, the CDX12 (this is the index of credit default swaps for 125 investment grade names) tightened (spread came down) towards 170bps (from 182bps at closing of Friday). I wonder if this had anything to do with the Goldman Sachs announcement, at 4:11pm yesterday…

Anyway, the above news are only the reflection of a bigger scene, shown below, for a better visualization of the issue at hand:

We will keep reading the bearish comments from those who see a bear market rally in stocks, as they single out all the horrifying figures of the real estate, labour, retail, etc. markets. There is nothing wrong with those figures, but this is not a bear market rally. It’s just the “relative” inflation Gottfried Haberler wrote about 77 years ago. Now, some people recognize inflation only by stage above, when liquidity reaches consumption goods (They are the same who then tell you we consume too much and don’t save enough!). In conclusion, as long as the Fed and all the other central banks keep flooding buckets with liquidity and feed us with daily announcements, we can see prices NOT falling. Looking at the picture above, do you think that by stage 5, an exit strategy by the Fed will be effective? Why?