Inflation, here we come

• Buy $5,000 of SunPower (SPWR, news, msgs) at the open.
• Buy $4,300 of JA Solar Holdings (JASO, news, msgs) at the open.
• Reinvest proceeds from any stops prior to these trades posting in the following order: $5,000 of Western Digital (WDC, news, msgs), $5,000 of Suntech Power Holdings (STP, news, msgs).
• Use trailing stops on my positions of 8% on the long side, 10% on the short.

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"No emergency can justify a return to inflation. Inflation can provide neither the weapons a nation needs to defend its independence nor the capital goods required for any project. It does not cure unsatisfactory conditions. It merely helps the rulers whose policies brought about the catastrophe to exculpate themselves." -- Ludwig von Mises

I am not sure one could have possibly summarized all of my concerns as concisely as von Mises did in the above quote. And while it applies perfectly to the actions of the trigger-happy Fed during the last several weeks, it was actually written almost four decades ago.

It isn't at all difficult to notice that the Fed's actions have brought a healthy dose of optimism and hope into the financial sector. And on the surface, this optimism is easy to justify. Lower rates lead to higher asset values on the balance sheet, lower headline write-downs, higher liquidity and higher investor confidence. Lawrence Summers, a former top U.S. Treasury official, was quoted in The Wall Street Journal last week saying, "Moral hazard and market confidence are different sides of the same thing. Sustaining confidence and preventing panics is itself a source of stability. It also economizes on capital and can encourage desirable risk taking."

And while I agree with him in principle, I also think that this kind of logic is what got us into the mess we are in the first place. It is true that in the short term, both monetary and fiscal stimuli are likely to lead to higher level of nominal GDP, earnings and potentially stock prices. But what I question is the logic and long-term benefit of such a frequent and radical government intervention into a market economy. The only thing that it could possibly do is fuel more inflation and misallocate capital from efficient use to ineffective waste.

Yes, I do believe the current creative destruction process in the financial sector is simply one of the normal symptoms of a well-functioning capitalist society. As one of the best central bankers in the world, Mervyn King of the Bank of England, noted, "The re-pricing of risk . . . is not a process that we should try to reverse."

Fed can't 'fix' the market

Adding ample short-term liquidity in the form of 30- to 60-day loans into the markets, as the Federal Reserve and European Central Bank have done during the last few months is perfectly normal. What's more, it is precisely what the central banks are supposed to do.

But reacting to normal fluctuations in the financial markets in such an aggressive fashion, with a 125-basis-point interest-rate cut over just two weeks, is simply reckless in my book. So what can I say: Higher inflation, here we come.

But I guess while we can question the Fed's decisions, we can't really undo them. So let's simply try to do what we can to make sure we are not the ones left behind picking up the bill when it comes due. I did a little study for myself last week; I called several large mortgage brokers and asked them about my refinancing options. I was astounded by some of the conversations. The lending officer at Countrywide Financial (CFC, news, msgs) said that the refinancing volume in the group where he works has doubled during the last four weeks, while the guy at Bank of America (BAC, news, msgs) implied a similar increase in volumes.

That sounds like a dream come true for the battered mortgage lenders. No wonder many of them have rallied so strongly, and I won't be surprised to see, for example, CFC's earnings to head north and may to even break even on an operating basis. So investing into some financial stocks may well be worth the risk in the short term, and who knows, maybe we'll even see a higher takeover price for a BAC/CFC deal.

But on the other hand, some lenders also noted that many people seem to be willing to refinance even if the long- termbenefit is questionable. Many consumers are in effect adding $2,500-$3,000 in closing costs to their loan balances while their payments go down by only $50 a month. That seems to confirm that consumers are quite desperate, and thus discretionary spending will still be under a lot of pressure in the next few months.

Haven't learned the lesson

That brings me to a final point of this discussion. How sustainable is that kind of shot in the arm, really? Haven't we seen this picture before? Is it really worth it for anyone to be a "poor dad," saving a large portion of his salary and putting it into safe fixed-income securities, if one could use borrowed money to finance a lifestyle they do not really deserve? How about concerns for the retirees on fixed incomes whose purchasing powers are being reduced by a whopping 4% inflation rate?

I thought it was just 12 months ago when we went through a period where everyone and their mother complained about budget and fiscal deficits, about Greenspan's loose monetary policies and the mess they triggered? Aren't we forgetting the $150 billion in losses and semi-bailout of Wall Street by Sovereign Wealth Funds? Enough said.

I am simply going to borrow some money myself. You can't go wrong with a 1%-2% inflation-adjusted "real" borrowing rate. When rates go up again, as they no doubt will have to, banks will again end up holding a bunch of assets that earn less than the cost of financing the loans. But for now, life might just get good enough for investors to believe that markets always go up.

Anyone who read my Strategy Lab Open blog for the last six months knows that not only I despise politics in general, but that I also believe that government can hardly do anything efficiently or effectively. I thus share the views of the Mises Institute that says that "government intervention is always destructive, whether through welfare, inflation, taxation, regulation, or war."

P.S. One thing is clear, though. If you are a short-term speculator, the Fed is definitely your friend. So please feel free to ride the greed train. If you don't, someone else will.

And one last note: In accordance with my strategy, I've put trailing stops on most of my positions, except for the "conviction" pick in my portfolio, Fushi Copperweld (FSIN, news, msgs).

Trade safe and cheers. Please visit me at my Web site, SkepticalCapitalist.com, and feel free to write me at SkepticalCapitalist@gmail.com.