cash inflation v credit inflation

[jk]

Cash or credit?

The current explosion in liquidity takes the form of credit [e.g bonds, mbs, abs, cdos, etc] instead of cash. Weimar was characterized by cash inflation, so consumption items soared in nominal value. I believe that the 1970’s inflation in the U.S. was characterized by a growth in the “M”s, cash and almost cash holdings. And that period, too, was characterized by sharp increases in the nominal cost of consumption items, as well as wages, thus producing the famed “wage-cost spiral.”

It is easy to imagine how a credit fueled inflation could feed into the housing market – we’ve just lived through it. But it is harder for me to imagine how an explosion of credit feeds into the economy once housing starts to collapse.

Doug Noland, at the Credit Bubble Bulletin, makes a suggestion:

@ http://prudentbear.com/creditbubblebulletin.asp ]
At this “terminal phase” of boom-time excess, the continued availability of cheap finance will innately attract boundless ideas for how to procure it and create wealth from it. Earlier this decade, when stocks were no longer the ticket, the boom just shifted to houses, commodities and emerging markets. If houses no longer cut it, well, then why not office buildings, energy, or even telecom – again! It doesn’t really matter; the Financial Sphere profits in any case.

But is this what is indeed happening?

He goes on:

@ http://prudentbear.com/creditbubblebulletin.asp
As demand for home mortgage borrowing has waned, lenders have simply responded with more aggressive commercial real estate and C&I lending. Losses on energy trades have only impelled the leveraged speculating community to press bets in the bond and Credit markets. The upshot is that the housing slowdown has to this point proven a catalyst for only greater Credit Availability and Liquidity throughout corporate and global finance. Little wonder, then, that U.S. employment has held up so well, while Income Growth has accelerated at home and abroad. Ultra-loose Financial Conditions are spurring the hedge fund, proprietary trading, M&A, LBO, derivatives and stock repurchase booms that play a critical role in handing the asset inflation baton effortlessly from U.S. housing to global debt and equities markets….

Some analysts describe Fed policy as “tight,” while forecasting that pricing pressures (generally “core” consumer price indices) will soon wane. And it is ridiculous that seasoned economists and market professionals continue to cite tepid growth in M2 as evidence of system “tightness” and Fed restraint. Why ignore that outstanding commercial paper has been expanding 21% annualized, Bank Credit 9.7%, and Money Market Funds 12.8% (as issuance booms for a variety of Credit instruments such as ABS, CDOs, corporates and Treasuries)? Truth be told, general Credit and liquidity (“Financial”) Conditions remain loose as ever, with indications of serious price distortions, not unexpectedly, as prominent as ever. [emphasis added]

During the housing boom, expanding credit fed into the general economy via consumers withdrawing cash from their nominally rising home equity. How do the more recent, more exotic expressions of credit excess feed into the general economy? Or do they?

I suppose that there is always trickle down from the multi-million dollar bonuses of Goldman partners and the outsized earnings of hedge fund managers. But it’s hard to see this supporting the economy. I fail to see how a still more rapidly expanding financial economy is going to monetize Joe Sixpack.

So questions:

1: where does the liquidity flow? Where’s the next bubble? Any nominations?

2a: what happens if the increase in credit is essentially confined to the financial sphere, and doesn’t make it to the real economy [except for demand for gulfstream jets and hamptons real estate]? Is this even possible?

2b: Will the housing crunch in progress cause the real economy to contract even while credit instuments proliferate? I.e. can we have real economy deflation combined with financial economy inflation?

2c: does the fed then monetize all the paper so that we get closer to the 70’s or Weimar model? Alternatives?