From Mark Grant, author of Out of the Box

"The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand - a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers. Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending - namely, recession, rising unemployment, and financial stress."

                         -Fed Chairman, Ben S. Bernanke

There was an argument, brought forth by several bright people; that the odds of Inflation or Deflation were about in balance for the remainder of this year. I think the needle has swung though and that Deflation, and perhaps serious Deflation, is just ahead of us. Every country in Europe is in a Recession with the exception of Germany but I predict that they are going to be dragged into the Club in the next quarter. The aggregate demand for goods and services is markedly declining all across Europe and the Target2 remedy to finance purchases is no longer providing the desired effect as financing only helps when demand is present and once demand has declined it makes very little difference as to the cost or availability of funding.

"Booms last longer because optimism is fed by slowly rising emotions involving hope and greed, which, because they are tempered by caution, can reach maximum intensity only over a long period of time and fulfillment only after prolonged effort. Busts are swifter because pessimism is fed by fast-flaming emotions such as fear and anger, which can be realized in a flash of destructive action."

                        -Robert R. Pretcher

The banking system, not just in Spain, is in tatters and the lending in the domicile of the banks is eroding as signified by all kinds of data released recently. Lending outside of the domicile has declined even further so that growth is curtailed by the availability of funding and the further away from the national home of any European bank; the worse the problem. This is then why I am so negative on the Emerging Markets as a safe place to park money. The lack of available funds will dampen growth so that the European recession spreads worldwide as contaminated by the problems of the European banks which, in aggregate, are about five times the size of the American banks and much more active in global lending.

“The modern theory of the perpetuation of debt has drenched the earth with blood, and crushed its inhabitants under burdens ever accumulating.”

                        -Thomas Jefferson

We have recently witnessed a boom-and-bust cycle in Real Estate in Europe that overcame the banks of several nations including Ireland and Portugal. Now Spain is about to show up to be counted in my view. The issue all across Europe is that the sovereign does not have enough assets or capital to bailout their banks and many European banks are impaired; make no mistake. The first move was to lay off a lot of non-performing assets in securitizations at the ECB but the price always gets paid which will either be severe losses at the ECB requiring re-capitalization or the ECB handing back the collateral to the various banks which would probably bankrupt some of them especially in Spain, France and Italy. The ECB maneuver brought early success but now, as loans become due and as non-performance builds and losses must be recognized; the real truth forces itself upon balance sheets. There is a day when the auditors say, “Show me the money” and when it isn’t there the infamous “Oh My God” moment begins.

Now Bubba, when you use the screwdriver and release the air from the tires it causes all of those little lights on the dashboard to begin to flash and then if you try to drive the car it goes “bump-bump” down the road. No Bubba, get off of your knees and get your mouth off of the thingy; you cannot blow air back into the tires that way.