Hello, Deflation!

From Bloomberg, we have China Raises Lenders' Reserve Ratio to 10 Percent.

China ordered banks to set aside more money as reserves for the fifth time in eight months to cool inflation and investment in the world's fastest-growing major economy.

Lenders must put aside 10 percent of deposits from Feb. 25, up from 9.5 percent, the Beijing-based People's Bank of China said in a statement on its Web site, immediately before the start of a week-long Lunar New Year holiday.

Also from Bloomberg, we have India RBI Raises Banks' Cash Limit to Stem Inflation.

India's central bank increased the amount of cash lenders must set aside to cover deposits for the second time in as many months to curb inflation that accelerated to the fastest pace in more than two years.

Banks in Asia's fourth-largest economy have to keep cash equivalent to 6 percent of deposits starting March 3 from 5.5 percent now, the Reserve Bank of India said.

This is the crudest weapon in the hands of any Central Bank.

This is the equivalent of trying to do heart surgery by using a hand grenade. Not only does it kill the patient but it kills the perfectly healthy doctors and nurses, and destroys all the expensive equipment in the room, for good measure!

(Basically, it penalizes all banks equally. That means, the "good" ones get penalized as much as the "bad" ones, and that's assuming the "bad" ones don't go under.)

There's no way out for the net-debtors: Japan, the US, Britain. Raise rates, or watch your currency collapse. Most likely, Japan is going to be first on the chopping block.

If Japan raises rates, and the US keeps them constant, the carry trade slips a little which creates a bit of panic in the derivatives market, which destroys MBS'es, which destroys the housing market. So the US is forced to raise rates which destroys the housing market directly. And if the US drops rates, the carry trade collapses completely which sends the whole financial system into hell which also destroys the housing market.

Best case scenario: both Japan and the US keep rates constant (or rising in sync very very slowly) which lets the housing market destroy itself (through foreclosures.)

Did I miss anything? Or is it time to invoke the law of the excluded middle?

The real question is: does Bernanke have his fingers and toes crossed?


We live in interesting times, the kinds that only come once a century!