Stress test reveals that capital is needed

Despite showing that the major banks need capital, financials rallied through the roof as it wasn't as bad as feared. Bank of America after being down 10% in premarket turned it around and ended up a whopping 17%. Not meaning to be the a doom mongerer but this rally is getting a bit out of hand, and so do another 90% of people out there, who are stunned at the sustainability of this rally. But as long as it keeps going up, better to be on the right side then stand in front of a speeding train.
it is likely we will breach 9000 in the Dow pretty soon at this rate, as there is no sign this rally is to be halted.
The rally in stocks was also due in part to a better then expected ADP jobs number which is often a preview to what the main non farm payroll will be. The data showed job losses of -491k rather then the expected -600k +. This sparked a sell of in bunds as we went below 122, and this morning the sell off is continuing as we are trading 121.86 down 23 points for the session.
All eyes are on the interest rate decisions from UK and EU, as well as results from AIG and official stress test results due later on today.

Although things look rosy on the stock front, this is a little piece on inflation, and a reminder that the problems haven't gone yet, and there is still an uphill mountain to climb.

INFLATION

Inflation is the furthest thing from most investors’ minds during this deep recession and financial crisis. It should not be. The unprecedented size of the government’s spending programs, entitlements, guarantees, and its lack of strategic thoughtfulness, point to an inflationary potential that is unique in the history of this country.

Preserving the long-term purchasing power of fiat currency is really hard. Even when government officials understand the dangers and are determined to avoid debasing their currency, the drift toward inflation in fiat money regimes is virtually inevitable.

Politicians make grandiose promises in order to get elected, and if the commitments are scheduled to come due years after they leave office, most civil servants are not very disciplined about making sure that those promises are paid in the purchasing power with which they were incurred. It is considerably easier to debase the purchasing power of currency, thus diluting claims, than to exact overt taxes. Inflation is a powerful wealth transfer or wealth confiscation device, because taxes are levied not on the real accretion of wealth, but on the nominal price increase or interest payment. Governmental borrowings to spend on current items that have no lasting value can have important inflationary aspects; as debt increases, well beyond the rate of actual economic growth, powerful incentives are introduced to debase the currency rather than repay the borrowings at full value. These elements and truths are universal and reinforced by history. Ignoring them can grease the path toward societal destruction. Debt collapse, massive unemployment and negative economic growth can destroy societies and lead to violence and authoritarian governments which create large changes in the basic fabric of life. However, serious inflations can have the same effects. They can be absolutely ruinous, and history abounds with examples of societies wrecked by massive debasement of currencies and the destruction of people’s savings.

It is really important to focus on this now, despite the falling prices of many commodities and assets and the lack of pricing power of businesses and wage-earners. Here is the reality of the global governmental programs meant to stem the current financial crisis and recession: if they spend enough money, they will stem the decline. If they guarantee enough financial institutions, they will prevent the fall of the global financial system like so many dominoes. The actions taken to date, and promised for the future, exceed by a very large margin all historical examples of governmental action to address economic and financial distress. Governments which have promised to do “whatever it takes” to avoid their nightmare memory of the Great Depression are certainly being straightforward about the size and speed of what they are doing. The only thing that is missing, which is far from trivial, is any real analysis of the long-term impact of their actions. We really cannot understand the thinking behind the conviction on the part of policymakers and many investment managers that the unprecedented monetary ease and governmental borrowing will not cause significant debasement of purchasing power. It is as if they think there is nothing to learn from history, but they have not revealed any basis for this mindset.

It took 20% interest rates in the early 1980s to wrestle down the inflation that kicked off in the late 1960s. It is unfathomable to consider what could happen in the ensuing stages of the current cycle, given the substantially greater excesses and lower discipline preceding this crisis. Moreover, the transition from deflation to inflation could be very abrupt. We really don’t know whether this is likely to occur in the next few months (doubt it, but not impossible), or in a year or two or later, but when it inevitably gets underway, it is bound to be a very large problem.