Looming Inflation a Matter of Fact, or Faith?
by Lee Adler
I got this question this morning from a poster over on the Stool Pigeons Wire.
Am I correct in stating that regardless of whether or not the new reserves that will be added once the FED purchases the GSE/MBS paper are utilized to increase fractional-reserve lending (at least initially), there would still be substantial direct monetization because the Treasury account at the FED will be credited by the same amount of the purchases ( since they are the conservators now?). Unless the FED and Treasury have some sort of agreement for the latter to not spend that fresh cash, I don’t understand how this would not be inflationary.
Am I way off base here? - coastiepilot
This spurred some discussion. My response follows.
Whether any expansion of the Fed’s balance sheet is inflationary or not I think depends on what the recipients of the cash do with it. It also depends on whether the expansion is really monetization or just a circle jerk. If the Treasury or the banks are deposting cash at the Fed, and the Fed then lends that to somebody else, or back to the same players, that’s just a circle jerk. Only if those players then lend to other third parties would the money supply expand.
We need a lawyer to explain how conservatorship works. I don’t think that the accounts of Fannie and Freddie are consolidated with the Treasury’s balance sheet. I also don’t know that the the funds would be deposited at the Fed, or where or what the GSEs would do with the funds. I also don’t know how much of the paper would be purchased directly from Fannie and Freddie and how much from third parties. What will the third parties do with the funds; hoard or lend?
Also, as I have discussed in the Fed report, the Fed is now stepping in where the FCBs have stepped out. What difference does it make to substitute a subsidy from one set of central banks with a subsidy from another central bank? I guess it depends on the relative size and timing of the purchases. The FCBs have already dumped over $100 billion of GSE paper in the past two months. The Fed says it will buy $100 billion. Not enough, since the FCBs will only pick up their pace of selling now that the Fed is willing to replace them as bagholder of last resort. The Fed says that it will buy $600 billion of other MBS. What will the holders do? Will they lend, or will they just breathe a sigh of relief, say “thank you very much” and stick the cash in their pocket?
So although virtually everyone is doing it, I don’t think it’s prudent to automatically assume that any of this will result in inflation at any time in the forseeable future. We remain in a deflationary debt collapse, and until I see evidence that this slide is beginning to reverse, I want no part of any major committment to an inflation trade.
I am more interested in what is than in what will be, because I don’t think in this environment that you can count on any particular outcome. The trick is to identify when the game is changing as early as possible, but not too early. That is the point at which we adjust our strategy and tactics.
Japan already tried all this crap and they were never able to inflate. Why the inflation camp ignores this obvious and undeniable fact, I don’t understand. I suppose it comes back to what I have said in the past about the attachment to gold being more like religion. Goldbugs hold gold as a matter of faith. Not that there’s anything wrong with that. Sometimes it works. It has worked since 2001. I’m just not sure that it will continue to work in this environment. So call me an agnostic on the potential for future inflation.
Those are my thoughts at this time. I will continue to discuss these issues in greater depth in the Wall Street Examiner Professional Edition Fed Report. An update will be published today.
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Aaron Krowne wrote:
My recent research suggests that severe inflation ultimately hits debtor nations due to a loss of confidence — not due to money printing and increase in “money velocity” per se.
There are no counter examples. Japan is not a debtor nation. Most of its debt is to itself.
Posted on 02-Dec-08 at 9:59 am | Permalink
Stuart wrote:
Yes, the value of a currency is dependent upon confidence in that currency. A central bank buying its own currency is damaging to confidence in that currency. Ourboros.
Posted on 02-Dec-08 at 11:26 am | Permalink
Don wrote:
Aaron:
As it regards loss of confidence: what matters most is not confidence, whether found or lost, so much as what explains or lies behind the loss or finding of confidence.
Confidence is a matter of perception. Certainly perception forms outlook, and as a result can form outcome. But it is even more true that real material forces shape perspective, and thus determines whether one is confident or not. In this sense, then, confidence is more a matter of effect than cause.
Sometimes said forces take time to settle in, and a confidence game can delay or conceal those forces. Consequently, emphasis on confidence often reflects more a matter of marketing, public relations, shaping opinion, etc., geared as it is towards forming expectations.
But in the end, confidence found . . . can easily become confidence lost.
Posted on 02-Dec-08 at 5:35 pm | Permalink
Ruth Smith wrote:
The ~2006-2010 business cycle is still in its deflationary depths. Almost all commodities have been taken down and the dollar has rallied. The inflation question will be answered when these 2 classes (and gold, in particular; it has also held up the best, since it has also been a safe haven play) reflect it, i.e., dollar weakens and commodities move up from a solid base. We are likely 12-18 months from such a phenomenon, since that time will start discounting an upswing in the business cycle. Cash, govt. bonds and bear funds are still winners. KISS.
Posted on 02-Dec-08 at 6:43 pm | Permalink
stevieo wrote:
The mechanism isn’t so much debtor vs creditor nations but in how new bank notes (central or otherwise) are financed. If they’re financed internally, it’s not inflationary because money’s just moving from other internal sources. It’s inflationary if it’s financed externally because there’s a net addition of bank notes (loosely speaking, money substitutes) internal to the economy. It follows that it’s the debtor nations that are financed externally, so they have inflation. Creditor nations finance internally (even to the extent that they can finance other nations) so they don’t have inflation.
A second point is worth making. An increase in credit or notes or money substitutes is never deflationary. The deflation Japan had and we’re having is the result of credit collapses. It’s just that all the new credit being created by the Treasury and Fed–and previously by Japan–are financed internally, so it can’t offset the deflation of the credit collapse.
Finally, is the US a creditor or debtor nation? I think some thought on that point would prove the point that it’s not so much creditor vs debtor as where the financing comes to fund the inflationary policies (which is what Treasury and Fed are trying to do–keep prices from falling) after a credit collapse.
Posted on 02-Dec-08 at 9:06 pm | Permalink