Expecting Hyper-Inflation: Fed Chooses to Monetize America's Debt

Word has probably spread around by now that the Federal Reserve is going to buy everything in America that's not nailed down, throwing another $1,150,000,000,000 lifeline at markets. (Click here to see what a trillion looks like.)

The Federal Open Market Committee (FOMC) informed the public this week that it will expand its dominating position in the MBS market, throwing an additional $750 billion there. The buying spree does not end there however. Having arrived at zero interest rate policy 3 months earlier, the Fed now hopes to control interest rates by monetizing US Treasuries in purchases equalling $300 billion. Stirring still more Bourbon in the punch bowl, the Fed will also up its portfolio of agency debt by another $100 billion.

Markets rallied on the news with Treasuries shedding up to 51 basis points. Gold outshone everything and spurted more than $50 on the FOMC's news that will ultimately lead to higher inflation rates despite the FOMC statement that claimed:

In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued.

Surprisingly chairman Ben Bernanke and his troops are more worried about possible deflation despite the Fed's ballooning balance sheet that will pass the $3 trillion mark this year.

Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

The latest CPI figures show a different picture. Inflation rose to 0.5% (January: 0.4%), or 6% annualized in February.

click to enlarge

GRAPH: Gold reacted with the biggest jump seen in decades, rising more than $50 after the Fed released more measures that are designed to fuel monetary inflation. Chart courtesy of kitco.com

Economists were up in arms about the Fed's measures. Stephen Stanley of RBS Greenwich Capital said via the WSJ blogs:

The agency MBS market is close to $4 trillion, so the Fed will end up owning almost one-third of the agency mortgage market. If this was a “rigged market” (to quote one of my learned colleagues on the mortgage desk) before, what should we call it now?! … $50 billion per month in Treasuries pales in comparison to new supply. Just to flesh that point out, we project that auctions of 2’s, 3’s, 5’s, 7’s, and 10’s will total $150 billion in March. In essence, even if all the purchases are limited to 2’s to 10’s, the Fed’s program will merely be a third of the new supply (and far short of one-third of the total market, as is the case for agency MBS).

Morgan Stanley's David Greenlaw added:

Even with energy prices having flattened The Fed’s Treasury purchases will absorb a very significant portion of the amount of gross issuance that we anticipate to occur over the next six months… The Fed’s announcement signals a clear intent to continue to drive mortgage rates lower and we expect them to meet this objective. This could represent a powerful source of stimulus for the household sector of the economy. In 2008, the average mortgage rate on the outstanding stock of loans was about 6.50%. So, if the Fed brings 30-yr fixed rate mortgages down to 4.50% and all homeowners are able refi, the aggregate permanent cash flow savings would be on the order of $200 billion per year.

Bloomberg summed it up in the lead of their coverage:

By committing to buy Treasuries and double his purchases of mortgage debt, Federal Reserve Chairman Ben S. Bernanke signaled his determination to avoid a repeat of the Great Depression and his willingness to pump as much cash into the economy as needed to end the current crisis.

I conclude nothing has changed in the Fed's perception that new fiat money will also solve this crisis. Taking gold's reaction as the canary in the coal mine, markets will recognize that the Fed is on the way towards hyper inflation. As in the Weimar Republic, the US central bank spins up the presses to monetize the debt. At the end of the Weimar Republic, one percent of government income came from taxes and 99% came fresh from the printing presses.

President Barack Obama may have no other choice than to take this route as foreign investors grow wary about the capability of the USA to serve its debts and we may see less participation in Treasury auctions, also for the reason that sovereign wealth funds will spend a bigger portion domestically, as nearly every nation is confronted with the economic downturn. For the time being, gold investments may turn out again to be the safest asset to hold.

UPDATE: Mint.com says one trillion greenbacks could fund an inflation-adjusted New Deal twice over. Check out their way of visualizing what one trillion can buy and get a dose of reality.

I especially liked this one. Do you still say this crisis is manageable? Illustration courtesy of Mint.com

Comments

[devassocx:]

Deflation? Except for house prices and consumer electronics just
where is this happening? I don't see it in the routine things I purchase.
I see inflation and I see a lot of it.

You say gasoline and other fuels are cheaper? Yes, that is because
we came off an enormous bubble, not because of deflation.

The gov't has chosen to get out of this recession by inflating unmanageable debts to manageable levels. They also under measure
real inflation by a tremendous amount. So much for honesty.

Mar 21 05:22 PM

[trader58:]

Why is it people still have a hard time seeing what really drives the economy. We have just witnessed the best example we could ever have hoped not to see and the majority are still deceived. It's the INVESTORS not buisness. Without investment there is no buisness. When the investors pull their money out there goes everything. What the government is ultimitly trying to do is coax investors back in to the economy, if they can do that then a turn around becomes likely, if they cannot then everything else they do is just an exercise in futility. The main thing to watch for is will the investors like it.

Mar 21 08:23 PM

[SW Richmond:]

Hmmmmmmm....documentat... Do you mean analysis? I've been down that street lots of times, let me tell you where it leads. We could not even agree on what "money" is. We would be reduced to arguing whether or not "credit" is "money" (for example, no doubt you think it is, while I think it is not). We would be further reduced to arguing whether or not "borrowed capital" in a fractional-reserve system is a lie in itself, since in such a system "capital" is loaned out at least ten times. We would argue endlessly about "velocity" and other monetarist nonsense.

Could we agree on a definition of "inflation" and "deflation"? I am certain we could not. A meaning for "Hyperinflation"? Not in a million years.

Let me tell you where I have found the difference lies between deflationists and inflation / hyperinflationists. Deflationists believe that the Fed can EITHER: save the system and later successfully manage to extract themselves from their position astride the entire global financial system, OR or they believe that something will stop the central banks from destroying the currency. Almost invariably (e.g. Shedlock), they believe that the credit markets will put a stop to "fiscal insanity" by causing government borrowing rates to rise. For some reason, they believe that when rates rise due to increased demand for borrowing by government that central banks will relent and say "OK, you win, we quit". The Fed's announcement, obviously coordinated with BoE's, SNB's, BOJ's et alia, regarding QE does not seem to make an impression. Or maybe, like Denninger, they just didn't think the Fed had the balls to do it.

Silly undereducated inflationists / hyperinflationists are quick to point out that the mere act of announcing printing caused the value of the printed currency to fall, and the prices of gold and oil to rise. And you might say "Yes, but those are temporary rises caused by morons panicking and the prices will fall once demand fails to materialize", and I will respond like this:

"What makes you think they won't merely continue to print until they get the desired effect? Do you believe they have morals, or scruples, or are you merely unable to imagine the unimaginable? Don't you understand that they MUST continue to print right up to the bitter end, because otherwise they would be admitting that central banking is a failure and that they are impotent liars and fools? Are there ANY circumstances under which that is possible?"


On Mar 21 03:24 PM WAKEUP wrote:

> Today, here, Vox wrote, "I've yet to see anybody provide any analysis
> about WHY the increase in the Fed's balance sheet will cause inflation
> - it's just assumed. And you know what happens when you assume..."
> I, too wonder why there is such a lack of documentation on this point.
> And I STILL don't believe that ANYBODY knows how all this is going
> to turn out. Remember, it IS different, this time.

Mar 21 08:35 PM

[H. E. Canada:]

I refer you to the DOW / Gold Ratio for a glimpse of what has already happened to the "value of the dollar" as represented by the value of the DOW. Ten years ago it took nearly forty five ounces of gold to "buy the DOW." Today it takes less than nine ounces to do so. Relatively speaking, that's an 80% loss in the value of the DOW, or about twice the usually reported loss as based solely on the fiat currency, a.k.a. the US dollar. (For an example see: Chart of the Day at www.chartoftheday.com/...)

Whether you look at dollar-denominated inflation-adjusted charts or the DOW / Gold Ratio chart, it is obvious that U.S. equity markets have been in a bear market "value-wise" for over nine years. In fact, the DOW and the S&P 500 are trading at 1997 levels, before adjusting for inflation! Not so rewarding.

I cannot predict whether we will have deflation or not, but I am persuaded that we will have significant inflation or hyperinflation in the next couple of years. With any recovery, given the unprecedented monetary stimulus pumped into the economies of the world, who can seriously doubt the inflationary certainties awaiting us?

Have we forgotten that just last year oil was at $140 / barrell and that many other commodities were spiking? With even more money to chase those goods, many of which are at lower production and inventory levels, high inflation seems a reasonable expectation. Also, deflated real estate and derivative paper assets (MBS, CDS, CDO, etc.) will attract billions (trillions?) of fewer dollars in the foreseeable future. Many of those dollars will be put into commodities and hard assets (mostly other than real estate and buildings), adding to the upward pressure on them.

So, what is there to do? My bets (along with China, Jim Rogers, George Soros, and many others better-healed and more experienced than I) are on gold, silver, commodities, and on scalping short-term, high probability vertical spreads for cash flow.

As cynical as it may sound, I think there are very few trustworthy people pulling the levers right now in Washington and on Wall Street. "The polls" seem to agree with that statement. Until trust returns to the market and politics, the paradox of savings will thwart many efforts at recovery as people, and certainly knowledgeable investors, try to protect themselves.

This will probably prompt the government to continue the wrong-headed actions of hyperinflating the money supply. Eventually, the money will show up in the economies of the world, and at a velocity greater than the governing authorities can throttle. Begin reading again at the top of this post for the predictable results.

Mar 21 08:57 PM

[Dan H:]

One way or another there will be inflation. It is the only real tool of the FED, and they have been using it all along. The debt will never be paid, and it is growing like a giant cancer. The only way to cope with it is to diminish its value. When trash pickup folks are earning $100K, then we will ALL be paying taxes on the "wealthy".
Do you think this has not been anticipated? How many of these taxes have been indexed for inflation? We are all in the cross-hairs.
Obama in short: Bail out the Failed using taxes on the doers like "Joe the Plumber". So much for Change-we-need, more like Same Old S**t

TEA PARTY anyone?!!

Mar 21 09:22 PM

[Vox Rationalis:]

H. E. Canada wrote:

> I refer you to the DOW / Gold Ratio for a glimpse of what has already
> happened to the "value of the dollar" as represented by the value
> of the DOW. Ten years ago it took nearly forty five ounces of gold
> to "buy the DOW." Today it takes less than nine ounces to do so.

But how 'bout we look at 20 years ago? On the last day of 1988, an ounce of gold bought 1.53 "shares" of the S&P 500. Since then, the ounce of gold has appreciated from $401 to $953, while the $401 in the S&P 500 has increased to at least $1,273 (that's paying 30% tax every year on that year's gains). So the S&P side is up 210%, while the gold side (after just 20% tax on the gain) is up 110%

Wanna try 30 years? On the last day of 1978 (the year before gold went up 132%), $226 bought you an ounce of gold that's worth $953 today, for a gain after 20% tax of 357%. The $226 in the S&P 500 would have grown to at least $2,070 (again paying 30% tax every year on that year's gain), or 816%. .

> Whether you look at dollar-denominated inflation-adjusted charts
> or the DOW / Gold Ratio chart, it is obvious that U.S. equity markets
> have been in a bear market "value-wise" for over nine years. In fact,
> the DOW and the S&P 500 are trading at 1997 levels, before adjusting
> for inflation! Not so rewarding.

I would be hard-pressed to come up with a better argument against buying gold in favor of equities now.

Mar 22 02:25 AM

[sjgold:]

well next week at G 20 and the UN, China, Russia and elsewhere the drumbeat starts to get away from the $US Peso as the world's currency. Over the coming days your statement will be proven wrong by the rest of the world....there IS a Global economy out there not just the US and THEY will move away from the dollar with very good reason.


On Mar 20 10:23 AM TaurusTrader wrote:

> In my opinion, the dollar related reaction to fed decision is a little
> over done. US economy is still the strongest economy in the world
> despite all our problems. Dollar is still the dominant currency.
> People who are squabbling over greenback, should just look back a
> little. Just 6 months ago, EUR/USD pair was trading at over 1.60.
> Now, when it jumped from 1.30 to 1.35 or so, all hell breaks loose!
> Very strong dollar in the past few months had hurt US companies doing
> business abroad. An example is ORCL, which reported a great quarter
> on Wednesday. ORCL beat the street estimate by 2 cents. Still,
> ORCL numbers would have been 5 cents better if it were not for a
> stronger dollar.
>
> So, relax folks. A slight decline in dollar is not the end of the
> world as the dooms day pundits like Larry Kudlow and his friends
> on CNBC rant about. The dollar is already stabilizing against the
> Euro and Yen as I write this response.
>
> Commodity prices need to go up as economic activities around the
> globe picks up ... that's excactly what is happening! There are
> signs that the global economy has started turning the corner.
>
> TaurusTrader
> taurustrader.wordpress...

Mar 22 08:01 AM

[User 152443:]

why isnt the gov going at the root of the problem" housing". First they spend 10% of gdp,then 20%, know I hear 50% and its not over, holy smokes thats alot of money where is all this money going.The american people are being deceived again and the media continues the brain washing , bonuses , evilbanks ,corruptcongress,whoto... enough already fix the problem. If 14 million mortgages are in trouble then subsidize them all.that will only cost tax payers less than 200bil a year and couple that with m2m changes the MBS market can function freely ,no more toxic.at least no more escalating toxic. But its probably better to spend 7+ trilion.

Mar 22 10:16 AM

[H. E. Canada:]

Some people may be satisfied with their dollar-denominated returns over the last ten, twenty or thirty years from a diversified investment in the DOW or S&P 500. Assuming they were prescient enough to have taken the gains out of the market at all the "right" moments (especially November 2007 - and staying out of the market since then) they can boast about their returns.

For the masses who are not so fortunate to have made all these correct and timely decisions, the last ten years have not been so rewarding. There is no question that there was money made in the market during the last few decades. Many of us took money off the table and put it in other assets or returned it to the economy as consumptive spending. Good times!

But, there is also no doubt that the equity market appreciation since 1997 has been wiped out. I cannot find an inflation-adjusted, tax-adjusted, or any other "adjusted" table or chart that says otherwise. In fact, applying a tax-adjust metric to the inflation-adjusted metric compounds the loss of value in the equity markets.

The pertinent question is where to put your assets for the near-term. Those believing that the equity markets are the best answer probably have a different outlook for the economy, inflation and taxes than those who expect other asset types to outperform, however you wish to "value" them.

Mar 22 10:29 AM

[trader58:]

What's value, how do you measure it, mark to market or do we get a small cabal ( Fed ) to assign it ?


On Mar 20 09:04 AM SW Richmond wrote:

> We've just witnessed the most significant day in American history
> in the last sixty-five years, and few Americans recognize it. It
> is nothing less than the day the US government admitted to the world
> it was insolvent. Pundits can yammer, but if any American family
> had gone to BK court and told the judge "we're going to print money
> to make our mortgage payments and maintain our lifestyle" there's
> no doubt what the judge would have replied.
>
> Our "president" is still campaigning and glamming it up, because
> that's all he knows how to do. Someone else, obviously the same entrenched
> power structure, is making decisions, and bad ones at that. We were
> promised change but have "stayed the course", not "changed horses
> in the middle of the stream", and gotten at least "4 more years."
>
>
> This is not going to end well; it can't. You can't print value, and
> everyone knows it. America, be ready. The welfare-warfare Leviathan
> is killing itself, and if we're not careful it will soon be replaced
> by its warfare-only cousin (since we won't any longer be able to
> afford welfare).
>
> It's a dark day.

Mar 22 08:56 PM

[Vox Rationalis:]

H. E. Canada wrote:

> Some people may be satisfied with their dollar-denominated returns
> over the last ten, twenty or thirty years from a diversified investment
> in the DOW or S&P 500. Assuming they were prescient enough to
> have taken the gains out of the market at all the "right" moments
> (especially November 2007 - and staying out of the market since then)
> they can boast about their returns.
> For the masses who are not so fortunate to have made all these correct
> and timely decisions, the last ten years have not been so rewarding.

Don't know about you, but I try not to cherry-pick results. You pulled a 10-year number, I pulled equivalent 20-year and 30-year numbers -- including the last 18 months. No timing involved.

Mar 22 10:04 PM

[Conan the B...:]

Vox is much better, much easier to reply to without sounding crude.

Gold has its place. On a purely opinionated basis, that place has to be part of one's portfolio: Part of versus all of.

Rhethorically, let's say Gold rises 200%, approaches $3,000 for whatever reason. Will I be happy with physical gold, you can bet your Bippy on it.

Will I be beating myself with a 2 by 4 for not investing in the Gold Miners, you can bet on that as well.

200%? Big Deal, the big boys will probably be up a 1,000%. The Junior Miners with some production and promising assets will be up 2,000%. Stocks with Gold in their names will go up just because of it.

Maybe, it occurs once every 35 years, but if the current move is anything like what happened back then, the better call is to go with the Miners.

You can Cherry Pick stats to match whatever you desire. For Instance, Take the poor results from BRK over the last 10 years. The reality is that had you bought at its bottom of $44,000 in the last bear, you would have made around 250% compared to the DOW or S&P's approx. 100%.

BRK has cycles, they can last for years without appreciable moves but If you were stuborn enough to hold on through them, well...

In the Mid-70s, I believe BRK could be had for $100. In 1982, I believe that it was around $500. After that, it hasn't really looked back.

Given 35 years to work with I can find whatever I want within the Time Frames of my choosing.

Mar 23 03:07 AM

[SW Richmond:]

While admitting the inherent unreliability in the definition of "money", I have engaged that circular argument enough times to know to avoid it.

Quoting myself: 'It makes absolutely no sense to be paid small amounts of money for a day’s labor when vast quantities of the same money can be clicked into existence at the whim of one man.'


On Mar 22 08:56 PM trader58 wrote:

> What's value, how do you measure it, mark to market or do we get
> a small cabal ( Fed ) to assign it ?

Mar 23 05:23 PM

[Vox Rationalis:]

paultaut wrote:
> Gold has its place. On a purely opinionated basis, that place has
> to be part of one's portfolio: Part of versus all of.

My beef with the goldies remains the same. Unless one is seeking protection against the breakdown of society, gold has no inherent advantage over crude, or natural gas, or silver. As an inflation hedge, at the moment I would certainly prefer silver and gas, and probably oil as well. The historical valuation of gold relative to these other commodities has simply gotten out of kilter as fear has overrun reason.

I've also said that I prefer equity investments to those that sit on a shelf, so my "hedge" would be companies that increase profits as commodity prices rise.

Mar 23 10:01 PM

[H. E. Canada:]

Cherries are appropriately picked when they are ripe. Profits are appropriately taken when they are available. It's always a matter of some sort of timing, even for the buy and hold mentality that is the only pony some know how to ride. Or is the pony in charge?

Analysis would be impossible if there were no "picking."

Mar 24 03:40 AM

[Vox Rationalis:]

H. E. Canada wrote:
> Analysis would be impossible if there were no "picking."

True, though for analysis to have meaning it must address bias, including bias resulting from limited sampling.

Our discussion started with you claiming to use the 10-year performance of the Dow 30 as a proxy for the U.S. dollar. Really, you were talking about equities, not the dollar. So I presented comparable data for the last 20 years and 30 years. To which you wrote:

"Some people may be satisfied with their dollar-denominated returns over the last ten, twenty or thirty years from a diversified investment in the DOW or S&P 500. Assuming they were prescient enough to have taken the gains out of the market at all the "right" moments (especially November 2007 - and staying out of the market since then) they can boast about their returns. For the masses who are not so fortunate to have made all these correct and timely decisions, the last ten years have not been so rewarding."

Which contains the implication that somehow the outcomes I presented for the 20-year and 30-year timeframes relied on market timing. To which I responded. Make no mistake - I never refuted and of your statements about equity returns over the last 10 or 12 years.

You closed with:

"The pertinent question is where to put your assets for the near-term. Those believing that the equity markets are the best answer probably have a different outlook for the economy, inflation and taxes than those who expect other asset types to outperform, however you wish to 'value' them."

I reject the premise, which is that the near-term is the only pertinent timeframe; all time horizons are pertinent. Equities are now historically cheap, which means that with a 10-year horizon (for example) they are likely to outperform most other assets. Will they get cheaper in the coming months? Perhaps, especially if the recovery is slow - hence the peril of market timing. It's worth noting that equities have proven to be quite a good inflation hedge, and that taxes don't seem to have a major role in these decisions.

So really it comes down to the investor's expectations regarding the economy over the investment time horizon. The shorter the horizon, the more likely the investor is to believe prospects are poor, and the more likely equities will not appear attractive. However, for the long term investor, the peril of timing the market is always lurking.

Mar 24 11:39 AM

[Airelon Tra...:]

Hyperinflation

: chuckle :

Inflation? Yes, probably. Eventually, someday, inflation will return.

Hyperinflation?

Stilllllll waiting. How many years does a group of people have to be wrong before they admit defeat.

Heheh.

Apr 18 06:04 PM

[Airelon Tra...:]

Still waiting for that hyperinflation.

LOL

May 07 12:52 PM

[Living4Divi...:]

I agree with AT

Will we see inflation ? YES
70's style inflation: Probably
Hyperinflation: NO



On Apr 18 06:04 PM Airelon Trading wrote:

> Hyperinflation
>
> : chuckle :
>
> Inflation? Yes, probably. Eventually, someday, inflation will return.
>
>
> Hyperinflation?
>
> Stilllllll waiting. How many years does a group of people have to
> be wrong before they admit defeat.
>
> Heheh.

May 10 07:10 PM

[Prudent Inv...:]

Thank you all very much!!! I am overwhelmed by receiving 50 comments on this post. I have to re-read all your comments and hope to answer your opinions/questions in the future posts to come. Nothing drives me more than such witty responses! Thx again.

Jun 10 06:28 PM