The Sequester – Deflation’s last gasp

2/26/2013 Portland, Oregon – Pop in your mints…

As the clock ticks down once again on another fiscal deadline, it would appear that the US and global economy are in for a brief bout with a familiar friend, uncertainty.  In the face of uncertainty, it is important to review one’s basic premises to be assured that they still hold.  Here at The Mint, we perform this analysis by way of presenting a list of Key Indicators at the end of each segment.

Most days, it hardly seems worth doing.  The data we track tends to stay in a fairly tight range.  However, were one to read The Mint say, two months ago, there may be a noticeable difference in the data points which would tell us something.  That something, for the past two years, has been that come what may, be it TARP, Debt ceiling votes, Euro zone crises, Fiscal Cliffs, or the latest version, the Sequester, our key indicators have consistently returned one answer as to what lies beyond the speed bump:  Inflation.

However, the drama that unfolds in the lead up to what can only be described as a failure to properly sends jitters through the most vulnerable parts of the financial markets, which circa 2013 are literally all financial assets.  The jitters are caused by a Pavlovian reflex that the markets have ingrained in their psyche at the hint of the POMO (the Fed’s Permanent Open Market Operations) running dry.

The POMO, for the initiated, is where the magic of QE and other monetary alchemy takes place.  It is where the FED exchanges wine for sewage, and it is increasingly difficult to say who is providing what.  In the end, it will all turn to sewage, and the end is always nigh, hence the Pavlovian response.

To illustrate the point, we offer an incident from our youth as an example of how the Pavlovian response of market exits (or risk off trading) works.  Though no animals were injured in the incident that follows, if you are a member or PETA or are sensitive to animal cruelty, you may want to jump below the graphic to continue reading.

When we were a young boy in Colorado, we had a dog that we would come to call the Rock long before an aspiring professional wrestler adopted the nickname and made it famous.

The Rock was an extremely lively dog and, while fun to be around and play with, he, like all young pups, wanted to get out and see the world.  To accomplish this goal, The Rock would dig holes under the fence and wriggle through them.  More often than not, the family would spend the better part of the afternoon patrolling the neighborhood in search of our four legged explorer.

Our Uncle, who lives in Nebraska and is a farmer turned banker, but was a farmer at the time, offered some advice on the matter.  As most people are aware, cattle and other livestock can be coaxed into staying in an enclosed area by running an electrified wire around the perimeter.  The trick is that the perimeter fence does not need to be live for the livestock in question to respect it as a boundary.

The reason for this is that the livestock are trained to have a Pavlovian response to the mere sight of the wire.  When the fence is installed or new livestock are moved to the enclosure, the wire is turned on and the electric current runs through the wire.  The initiated livestock stay clear of the wire and search for a good view as the new livestock, who are unaware of the fence’s magic powers, bump into the wire unaware and are promptly shocked, or as the farmer thinks of it, “conditioned,” to stay away from the wire.

We now return to The Rock.  Our Uncle, after hearing of our plight, offered to lend us one of the electric wire fences so that The Rock could be trained to stay within his confines.

We set up the fence.  The Rock watched the installation with interest.  We put the final length in place and then turned to The Rock for what we imagined would be a brief round of “conditioning.”

We stared by placing his paw upon the live wire.  There was no Pavlovian response on the Rock’s part, just the usual excited stare and panting.  Next, we tried the top of his foot, which was covered in hair.  Again, nothing.

We quickly touched the wire ourselves and satisfied ourselves that it had been turned on.  How could we get The Rock to understand that the wire was a force to be reckoned with?

Again, readers with PETA affiliations, if they have read to this point are encouraged to jump to the graphic.  This is the final warning.

It began to dawn on us that the reason that The Rock had avoided the shock to this point was that there was no moisture on his paw or hair (it was a fine summer day in an arid climate, after all).  All that was needed to get the current running was a bit of moisture.

It did not occur to us to grab a spray bottle to lightly moisten the dog and retry the relatively innate area of the paw that we had focused on up to that point.  What did occur to us was to grab a piece of raw meat and hang it over the wire.

What happened next remains permanently etched in the memory of all who witnessed it.

The Rock, delighted at the offering, immediately extended his tongue to retrieve the meat from the wire, the way he would have any food morsel that he was offered.  Naturally, he was shocked as his tongue made solid contact with the wire.

The Rock did not retreat at that point, rather, between yelps of both pain and pleasure, continued what was a vain attempt to remove the meat from its perch.

After about the third attempt, a shock of sufficient strength was delivered by the fence and The Rock abruptly turned and ran 180 degrees into the house.  We were standing at the door in disbelief as The Rock hit cheetah type speeds as he encountered us at the door.

We do not remember exactly how we ended up on our back, but we suspect we completed at least one full, albeit involuntary, rotation in the air before we arrived there.

In the background we heard uncontrollable laughter, and The Rock didn’t leave his hiding place under the bed for the rest of the day.

Strangely, the incident did not change The Rock’s attitude towards digging under the fence, and he managed to escape whether or not the electrical perimeter wire was on or off.

The Pavlovian response, which was so evident in his cheetah like retreat that day, had been completely forgotten.  It wasn’t until he was hit by a car and had his hip shattered some time later that He finally gave up carousing.

We take a brief break from our tale to welcome back PETA members and animal sympathizers and to provide the following graphic, which was created by Wells Fargo’s Mark Vittner and Michael Brown and comes to us via the Money Game.  The graphic looks at which states stand to lose the most income, on a relative basis, should the Sequester become a reality.  By extension, it shows which is most dependent on Federal government spending.  Not surprisingly, the noise attributed to the Sequester threat comes from the fact that those populations most affected on a relative basis reside near Washington DC.

Federal Spending as percentage of GDP by State
Federal Spending as percentage of GDP by State via Business Insider’s The Money Game

Those closest to Rome are the ones who will get scorched as it burns.  However, thanks to the Fiscal fire hoses provided by the POMO of the FED, the Sequester will barely register as a spark

So it is with government finances when the monetary premium is removed from goods in the natural realm.  The above mentioned TARP, Debt ceiling votes, Euro zone crises, Fiscal Cliffs have proved to be nothing more than the meat hanging on the electrified wire for the governments of the west.  The latest version, known as the Sequester, which is essentially the spawn of the August 2010 debt ceiling debacle, is simply more meat on the wire.

Traders will yelp and make a dramatic retreat, and then return to digging under the fence the next day.  They will continue to roam farther and farther afield until they are hit by a car, which will come when the FED is the only customer for US Treasury debt, and the incestuous feedback look of the money supply overlords and government debt and spending collapses upon itself.

At that point, analysis will be useless, as the entire system upon which present analytical tools base their assumptions will cease to exist.

While the moronic Sequester is important for doctors and those who make armaments for a living, (many of whom live very close to Washington DC, making for a vocal and visible constituency that will be impacted) it is meaningless, both in terms of reigning in government spending or slowing down, let alone stopping, the t