Fed Intervention, Market Response Confirm: We're on the Path to Hyperinflation

As most of us who have been watching the financial markets know, last week was quite a week. The Federal Reserve announced they would print money to buy Treasuries and mortgage-backed securities.

The Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.

The market promptly responded:

1. Gold shot up and stayed up; it is currently trading at $958 at the time of this writing. Silver is rallying as well, trading at $13.48 per ounce at the time of this writing.
2. The US dollar dropped sharply against all other major currencies.
3. Crude oil rallied above $50 per barrel.
4. Treasuries rallied.

From these events, we can deduce two things:

1. The Fed is clearly aggressively pursuing an inflationary monetary policy. This is further evidence that the Fed can do what it wants; if the Fed is truly determined to inflate, it will be able to do so, regardless of whether or not banks will lend. Monetary policy is a fiat matter.
2. The market is clearly willing to run from the dollar in the face of outright monetization.

As money supply is expanding while demand for US dollars is collapsing, and as dissatisfaction with the political environment in the United States is at a nearly unprecedented level, it is clear the ingredients for hyperinflation are in place. See our previous analysis of hyperinflation for a more detailed explanation.

Moreover, CPI data released yesterday by the Labor Department in the US noted that consumer prices rose for the second consecutive month. Should this trend continue, it sets the stage for a price/wage spiral, whereby higher prices lead to higher wages, which in turn lead to higher prices, and so on. Declines in demand due to higher prices may not be sufficient to stop prices from rising further should the Fed continue an inflationary policy.

The New Trading Environment

As we have discussed before, "playing defense" against monetary policy is crucial to wealth preservation in a centrally planned economy. Based on the signals the market and the monetary authorities have recently given us, here are some trading thoughts for the near future:

1. Gold and silver. I've advocated precious metals many times before, and continue to do so, as they are the conventional inflation hedge, and remain the market's monetary commodities of choice.
2. As the Fed is distorting the free market process in the Treasury market through intervention, Treasuries may be difficult to trade without technical analysis.
3. Watch oil. Should it continue to rise, which seems very likely to me, it would be further evidence of an inflationary spiral, as rising oil prices will lead to rising gas prices, which in turn will lead to rising prices, and a demand for rising wages. With that said, I find oil's behavior a bit perplexing, and thus I personally favor precious metals as an inflation hedge. Those with a larger capital base and a need to diversify, though, may seek solace in oil.
4. The stock market remains a trader's environment, even more so than before. Those who can use technical analysis to understand momentum will be best positioned to find profits in the stock market, in my opinion. Fundamental analysis will be less effective, as the Fed's interventionist behavior will make rational analysis difficult and perhaps fruitless.

Disclosure: Long gold and silver.

Comments

[Ray Lopez]

S. Patel is talking his book. He does not realize that you cannot predict hyperinflation given the data we have now. We're on the road to inflation though, that's for sure.

I'm long Au as well.

We're on a road to nowhere. Come on inside. Takin' that ride to nowhere. We'll take that ride. HA! - Talking Heads

2009 Mar 21 04:36 PM

[John D]

More experts??

2009 Mar 21 05:34 PM

[smartmoney123]

What effect , do you think, will the fed intervention have on the Market financial stocks, :ie, wfc- bac- citicorp etc. on Monday 3/23/09?

2009 Mar 21 05:37 PM

[jockeydog]

I believe the inflation happened when the IB's/Hedge funds were leveraged 35/1. The housing bubble was the hyperinflation, and it's correcting now. What we're seeing now is temporary inflationary tactics to normalize the deflation.

2009 Mar 21 06:08 PM

[cj51]

> Should this trend continue, it sets the stage for a price/wage spiral, whereby higher prices lead to higher wages, which in turn lead to higher prices

Which ignores the all to real possibility that unemployment will reach 10% or worse, which implies no higher wages. Some companies are cutting salaries right now. Ford is cutting. On average, the middle class has been treading water for a few decades now.

2009 Mar 21 06:24 PM

[ddtuttle]

We are currently experiencing deflation on a global level. World net worth has dropped something like 50%, an amount that dwarfs the amounts actually "created" by central banks. We are in a deflationary spiral that show no signs of stopping.
When prices finally stop going down we'll have assets worth a fraction of their former value and many times the corresponding money supply. That will be a recipe for inflation, but from massively deflated values and prices.
Until then cash (and gold) are king. Once the inflation starts, then you'll want to switch to commodities (and gold).

2009 Mar 21 07:35 PM

[Vuke]

A "price/wage spiral" ?

When so many have lost jobs or live in fear of such? It's a little premature but perhaps you are looking a few years ahead? The specter of deflation still lurks in corners but, either way, gold and silver should do well and, most importantly, hold value.

2009 Mar 21 08:31 PM

[Mad Hedge Fund Trader]

You can count on it. Way to go Ben! If pouring gasoline on the fire doesn’t work, try nitroglycerine! Some $1.2 trillion in new agency and bond purchases, including previously untoucheable long term treasury bonds. Goodbye dollar, hello 4% home mortgage rates. Just tack on another 3% to the 2010 inflation rate. The bond market had its biggest up day in history, gold soared $50, the euro gapped up 4%, and commodity prices roared. Citigroup (C) has quadrupled from $1 to $4 since last week, while General Electric (GE) has doubled from $5 to $10! Just when you think this guy has thrown in the kitchen sink, he shows up another truckload of kitchen sinks. I guess this is what a 1590 SAT score gets you.

2009 Mar 21 08:35 PM

[@TexasER]

"As money supply is expanding while demand for US dollars is collapsing,"

Demand for USD is not collapsing. It may collapse, but your statement is way ahead of the facts.

2009 Mar 21 10:08 PM

[Teutonic Knight]

As I related elsewhere in SA late last year, the government present courses of action are clearly "hellishly inflationary (after Carl Ichan's remarks on the original $700B Hank Paulson Bailout)".

The much-touted deflationary scenario is looking more like a myth now. Forget about the $4.9M ultimate luxury home in Naples, FL that was, and still is, being listed. You could go in with a 50% discount offer if you have the money. But such deflated jewel would probably be reserved for those bankers who just got their bonuses.

Want an example of inflation for ordinary folks like you and me? Get ready to pay a hefty tuition increase if your kids are heading out to state public university. State education budgets are being cut ruthlessly, and the colleges had no alternatives but resort to raise fees.

See what I mean by inflation coming?

2009 Mar 21 11:03 PM

[davewsail]

"Moreover, CPI data released yesterday by the Labor Department in the US noted that consumer prices rose for the second consecutive month. Should this trend continue, it sets the stage for a price/wage spiral, whereby higher prices lead to higher wages, which in turn lead to higher prices, and so."

Are you smoking something? Talking about a price/wage spiral is far fetched when unemployment is increasing at an alarming rate and employers are cutting wages for the first time snce the great depression. Don't forget that the labor market is governed by supply and demand just as any market is. Right now there is way too much supply chasing too little demand. Until that flips there will be no wage pressure.

2009 Mar 21 11:26 PM

[Homer II]

Simit, you said "...as the Fed's interventionist behavior will make rational analysis difficult and perhaps fruitless." and yet you recommend holding precious metals? What do you call the drop in metals prices last August if not "interventionist behavior" by the Fed? The government well know if precious metals are allowed to seek their true level, that the Dollar will fall inexorably as PMs rise. So, they "meddled" to suppress the natural tendency for Gold to rise beyond $1000/oz and forced it down into the $700s to crush the appetite of the wise investors... and prop up the Dollar to buy some more time.

So, do you think now, the government will allow metals prices to float up freely, speaking metaphorically?

2009 Mar 22 12:54 AM

[Vox Rationalis]

"The Federal Reserve announced they would print money to buy Treasuries and mortgage-backed securities."

Is that what they announced? So currency in circulation is about to increase by more than 100%, right?

"1. Gold shot up and stayed up; it is currently trading at $958 at the time of this writing. Silver is rallying as well, trading at $13.48 per ounce at the time of this writing."

And so they've almost regained what they lost in the last month. But not quite.

"2. The US dollar dropped sharply against all other major currencies."

Which is, by the way, exactly how we should expect the currency markets to react as world economies recover. Based on valuations over the last few years, the dollar should not be expected to remain this valuable on the other end of this recession.

"3. Crude oil rallied above $50 per barrel."

From its close the day before the Fed announcement: $49.04. Wow.

What about "5. Everything else rallied too. The S&P continued a two-week rally, adding 2.1% on the day."

"The market is clearly willing to run from the dollar in the face of outright monetization."

Sigh. Have we seen a "run from the dollar"? As I said, commodities regained most of the ground lost against the dollar in the last month. And for currencies, using the dollar index for simplicity, looks like a 3.5% drop since the Tuesday close. You have to go all the way back to mid-January to find this level.

How does this compare with last year's run TO the dollar? Well, it's early, and certainly this two-day trend could continue. But consider - for the five months ending in July, the dollar index moved sideways between a touch under 72 and 74. Between August 1 and November 20, it went from about 73.4 to 88 - a 20% move. Now THAT's a "run."

Of course, the dollar was historically low last summer. Based on recent history, which has seen the dollar decline pretty steadily from 120 in 2002 to the low 70's last year, my guess is that the current value +/- 5% is about where it "should" be.

"As money supply is expanding while demand for US dollars is collapsing..."

"Collapsing"? The dollar's up a couple of percent for the year, and to you it's collapsing.

"...and as dissatisfaction with the political environment in the United States is at a nearly unprecedented level..."

Are you saying Americans want to replace the American political system? Seriously, what are you going on about here?

"...it is clear the ingredients for hyperinflation are in place."

Such rubbish. You don' t have any idea how hyperinflation might occur. Your second article on the subject, and you've yet to describe any elements of a hyperinflationary scenario that exist or might exist in America. By the way - your threshold definition of 40% per year doesn't seem to be supported by economist/historians - 40% per month is closer.

"See our previous analysis of hyperinflation for a more detailed explanation."

I commented on it at length, including many questions that you chose not to answer. Some are listed at bottom.

"Moreover, CPI data released yesterday by the Labor Department in the US noted that consumer prices rose for the second consecutive month. Should this trend continue, it sets the stage for a price/wage spiral, whereby higher prices lead to higher wages, which in turn lead to higher prices..."

By your over-the-top rhetoric, here's what I guess you mean by "this trend": November-December inflation was -2.5% and January-February inflation was 0.7%. So "this trend" would result in March-April inflation of 3.9%, May-June inflation of 7.1%, July-August inflation of 10.3%, etc. Hey - keep this up for a couple of years and you'll get to Cagan's definition of hyperinflation

Like I said in my last to you - if the temperature keeps dropping like it has the last few hours, we'll all be popsicles next week!

"As we have discussed before, 'playing defense' against monetary policy is crucial to wealth preservation in a centrally planned economy."

A "centrally planned economy." You're not really being serious with any of this stuff, are you? This is just a gag, right?

"Gold and silver. I've advocated precious metals many times before, and continue to do so, as they are the conventional inflation hedge, and remain the market's monetary commodities of choice.

Which is better? Do you think gold's recent high valuation relative to silver makes silver a relatively better investment? Or since you're seeking protection not against inflation but against the total breakdown of society, is gold better because it's more valuable by weight? Do you suggest buying diamonds, too?

"As the Fed is distorting the free market process in the Treasury market through intervention..."

The Fed's been "distorting" the market for Treasurys for years. Did you know that at this time last year, the Fed owned $675 billion of Treasurys, which is more than twice as much as they've recently announced intentions to purchase? I'm guessing not.

"...Treasuries may be difficult to trade without technical analysis."

I should have known. So, have you seen the outline of Barad-d'ur in the recent charts, proving the odds of Armageddon are high?

"Watch oil. Should it continue to rise, which seems very likely to me, it would be further evidence of an inflationary spiral, as rising oil prices will lead to rising gas prices, which in turn will lead to rising prices, and a demand for rising wages."

Yeah. It sure worked out that way last summer, when oil was nearly three times higher than now, didn't it?

"With that said, I find oil's behavior a bit perplexing, and thus I personally favor precious metals as an inflation hedge."

Hilarious. You find OIL's behavior perplexing? Compared to gold? Then I guess you can't possibly figure out silver, which has historically been highly correlated with gold. Until about August, that is, when silver fell (along with every other commodity) and gold didn't.

There's nothing at all perplexing. Gold retained its value during this period, when other commodities were falling, because of fear. When people get scared, they run to gold. And since there's no reason to think that this fear will not subside, there's no reason to think gold's valuation relative to other commodities will fall back in line. Which means gold is by no means the best available inflation hedge.

"4. The stock market remains a trader's environment, even more so than before. Those who can use technical analysis to understand momentum will be best positioned to find profits in the stock market, in my opinion. Fundamental analysis will be less effective, as the Fed's interventionist behavior will make rational analysis difficult and perhaps fruitless."

This is perhaps the most foolish thing you've written. The Fed's actions will have very little impact on the vast majority of listed companies. Of companies with good prospects at good valuations, very few (if any) might be negatively impacted by the government's actions -- especially the Fed's actions. I'd actually say that the government's action is more likely to affect you fortunetellers than fundamentalists, since technical analysts are much more active traders.

This is an incredibly GOOD time to be buying equities. Using Robert Shiller's 10-year P/E valuation metric, the S&P 500 is cheaper than at any time in the last 23 years.

-----
Here are a few things I asked last time (since you brought it up):
Exactly how was the fiat-based monetary system the cause of this crisis? No, better question: how did we avoid crisis for so long with the same monetary system? Or do you think the current crisis took oh, 50 years to build?
Do you really think that, if the US currency broke down, that society would hold together well enough for foreign currencies to be useful?
And how much of people's wealth do you think they should hold physically, risking theft and loss while earning no return?
Why didn't you describe any scenario that might result in hyperinflation?
What are the odds of hyperinflation? Come on, put a number on it.

2009 Mar 22 01:41 AM

[Michael Hoeft]

He's right though IMO. Long Gold and Silver. And Yen.

2009 Mar 22 06:53 AM

[utilitus]

Comments above questioning the impact of a price/wage spiral in even the mid-term seem apt. But I don't understand inflationary transmission mechanisms fully. Another key dynamic motivating inflation is its' 'expectation'. Fed chairmen often talk about "anchoring" it - well, now they're fitting it out with hyrofoils, semaphore flags and steam whistles. It's perhaps the cheapest and most flexible tactic to actually engender inflation. ( I personally resent having to orient my well-ordered financial life according to the desperate requirements of late capitalism, where inflationary expectations are functionally propaganda. Makes me want to pop a cap in someones' 'output gap'.)

2009 Mar 22 10:14 AM

[Teutonic Knight]

To put it bluntly, I view the CPI as a bit of a joke.

It is meant to serving mainly the government purposes of having some form of a metric to adjusting Social Security, Medicare/Medicaid, and other payments, as well as for updating civil service salaries, and contractual purposes.

It would also give your boss (for those who are employees, myself included) some basis to meter out to you those meager annual merit pay raises.

Look at the so-called Boom Years of 2001-2008 with the Housing Bubble. New college graduates with their freshly-minted diplomas faced buying a single-family home at prices of $800,000 upwards in some hot metro areas. Did the government factor in these exuberant and outrageous price increases in their calculating the annual CPI? Obviously not.

2009 Mar 22 10:48 AM

[Teutonic Knight]

One final 2-cent of mine, sorry for being piece-meal, on inflation.

You are, and will be, paying more, for less...for many years to come as a result of the saga...

2009 Mar 22 10:59 AM

[Shelley S]

Superb work "Vox Rationalis (aka BS Detector)"... you have an impressive insight.


On Mar 22 01:41 AM Vox Rationalis (aka BS Detector) wrote:

> "The Federal Reserve announced they would print money to buy Treasuries
> and mortgage-backed securities."
>
> Is that what they announced? So currency in circulation is about
> to increase by more than 100%, right?
>
> "1. Gold shot up and stayed up; it is currently trading at $958 at
> the time of this writing. Silver is rallying as well, trading at
> $13.48 per ounce at the time of this writing."
>
> And so they've almost regained what they lost in the last month.
> But not quite.
>
> "2. The US dollar dropped sharply against all other major currencies."
>
>
> Which is, by the way, exactly how we should expect the currency markets
> to react as world economies recover. Based on valuations over the
> last few years, the dollar should not be expected to remain this
> valuable on the other end of this recession.
>
> "3. Crude oil rallied above $50 per barrel."
>
> From its close the day before the Fed announcement: $49.04. Wow.
>
>
> What about "5. Everything else rallied too. The S&P continued
> a two-week rally, adding 2.1% on the day."
>
> "The market is clearly willing to run from the dollar in the face
> of outright monetization."
>
> Sigh. Have we seen a "run from the dollar"? As I said, commodities
> regained most of the ground lost against the dollar in the last month.
> And for currencies, using the dollar index for simplicity, looks
> like a 3.5% drop since the Tuesday close. You have to go all the
> way back to mid-January to find this level.
>
> How does this compare with last year's run TO the dollar? Well,
> it's early, and certainly this two-day trend could continue. But
> consider - for the five months ending in July, the dollar index moved
> sideways between a touch under 72 and 74. Between August 1 and November
> 20, it went from about 73.4 to 88 - a 20% move. Now THAT's a "run."
>
>
> Of course, the dollar was historically low last summer. Based on
> recent history, which has seen the dollar decline pretty steadily
> from 120 in 2002 to the low 70's last year, my guess is that the
> current value +/- 5% is about where it "should" be.
>
> "As money supply is expanding while demand for US dollars is collapsing..."
>
>
> "Collapsing"? The dollar's up a couple of percent for the year,
> and to you it's collapsing.
>
> "...and as dissatisfaction with the political environment in the
> United States is at a nearly unprecedented level..."
>
> Are you saying Americans want to replace the American political system?
> Seriously, what are you going on about here?
>
> "...it is clear the ingredients for hyperinflation are in place."
>
>
> Such rubbish. You don' t have any idea how hyperinflation might
> occur. Your second article on the subject, and you've yet to describe
> any elements of a hyperinflationary scenario that exist or might
> exist in America. By the way - your threshold definition of 40%
> per year doesn't seem to be supported by economist/historians - 40%
> per month is closer.
>
> "See our previous analysis of hyperinflation for a more detailed
> explanation."
>
> I commented on it at length, including many questions that you chose
> not to answer. Some are listed at bottom.
>
> "Moreover, CPI data released yesterday by the Labor Department in
> the US noted that consumer prices rose for the second consecutive
> month. Should this trend continue, it sets the stage for a price/wage
> spiral, whereby higher prices lead to higher wages, which in turn
> lead to higher prices..."
>
> By your over-the-top rhetoric, here's what I guess you mean by "this
> trend": November-December inflation was -2.5% and January-February
> inflation was 0.7%. So "this trend" would result in March-April
> inflation of 3.9%, May-June inflation of 7.1%, July-August inflation
> of 10.3%, etc. Hey - keep this up for a couple of years and you'll
> get to Cagan's definition of hyperinflation
>
> Like I said in my last to you - if the temperature keeps dropping
> like it has the last few hours, we'll all be popsicles next week!
>
>
> "As we have discussed before, 'playing defense' against monetary
> policy is crucial to wealth preservation in a centrally planned economy."
>
>
> A "centrally planned economy." You're not really being serious with
> any of this stuff, are you? This is just a gag, right?
>
> "Gold and silver. I've advocated precious metals many times before,
> and continue to do so, as they are the conventional inflation hedge,
> and remain the market's monetary commodities of choice.
>
> Which is better? Do you think gold's recent high valuation relative
> to silver makes silver a relatively better investment? Or since
> you're seeking protection not against inflation but against the total
> breakdown of society, is gold better because it's more valuable by
> weight? Do you suggest buying diamonds, too?
>
> "As the Fed is distorting the free market process in the Treasury
> market through intervention..."
>
> The Fed's been "distorting" the market for Treasurys for years.
> Did you know that at this time last year, the Fed owned $675 billion
> of Treasurys, which is more than twice as much as they've recently
> announced intentions to purchase? I'm guessing not.
>
> "...Treasuries may be difficult to trade without technical analysis."
>
>
> I should have known. So, have you seen the outline of Barad-d'ur
> in the recent charts, proving the odds of Armageddon are high? <br/>
>
> "Watch oil. Should it continue to rise, which seems very likely to
> me, it would be further evidence of an inflationary spiral, as rising
> oil prices will lead to rising gas prices, which in turn will lead
> to rising prices, and a demand for rising wages."
>
> Yeah. It sure worked out that way last summer, when oil was nearly
> three times higher than now, didn't it?
>
> "With that said, I find oil's behavior a bit perplexing, and thus
> I personally favor precious metals as an inflation hedge."
>
> Hilarious. You find OIL's behavior perplexing? Compared to gold?
> Then I guess you can't possibly figure out silver, which has historically
> been highly correlated with gold. Until about August, that is, when
> silver fell (along with every other commodity) and gold didn't.
>
>
> There's nothing at all perplexing. Gold retained its value during
> this period, when other commodities were falling, because of fear.
> When people get scared, they run to gold. And since there's no reason
> to think that this fear will not subside, there's no reason to think
> gold's valuation relative to other commodities will fall back in
> line. Which means gold is by no means the best available inflation
> hedge.
>
> "4. The stock market remains a trader's environment, even more so
> than before. Those who can use technical analysis to understand
> momentum will be best positioned to find profits in the stock market,
> in my opinion. Fundamental analysis will be less effective, as the
> Fed's interventionist behavior will make rational analysis difficult
> and perhaps fruitless."
>
> This is perhaps the most foolish thing you've written. The Fed's
> actions will have very little impact on the vast majority of listed
> companies. Of companies with good prospects at good valuations,
> very few (if any) might be negatively impacted by the government's
> actions -- especially the Fed's actions. I'd actually say that the
> government's action is more likely to affect you fortunetellers than
> fundamentalists, since technical analysts are much more active traders.
>
>
> This is an incredibly GOOD time to be buying equities. Using Robert
> Shiller's 10-year P/E valuation metric, the S&amp;P 500 is cheaper
> than at any time in the last 23 years.
>
> -----
> Here are a few things I asked last time (since you brought it up):
>
> Exactly how was the fiat-based monetary system the cause of this
> crisis? No, better question: how did we avoid crisis for so long
> with the same monetary system? Or do you think the current crisis
> took oh, 50 years to build?
> Do you really think that, if the US currency broke down, that society
> would hold together well enough for foreign currencies to be useful?
>
> And how much of people's wealth do you think they should hold physically,
> risking theft and loss while earning no return?
> Why didn't you describe any scenario that might result in hyperinflation?
>
> What are the odds of hyperinflation? Come on, put a number on it.

2009 Mar 22 11:50 AM

[MarkitWacha]

Talk of both inflation and deflation is premature.

There is truth that we're riding along several points of inflection, ones that go both ways. In the following year or two, we'll find out how clever and skilled the Fed is at doing their job -- full employment and price stability.

Remember that to the Fed the market is just a tool, kind of how we think the politicians are tools. The board of governors can't keep their fat paychecks and rich political influence if they don't do their jobs. In the real world, economists aren't terribly productive. They're like physicists that work for hedge funds.

full disclosure: long commodities (and gold) via GSG.

2009 Mar 22 12:32 PM

[prudentinvestor]

World net worth went up through an artificial asset bubble, not through real value created by labor producing goods and services. The bubble burst because it was artificial and unnatural, and now the fed is re-creating it. The money the fed is printing will cause high inflation that will be impossible to rein in, in addition to further distorting the economy in favor of artificial asset values, and away from productive labor producing useful goods and services.


On Mar 21 07:35 PM ddtuttle wrote:

> We are currently experiencing deflation on a global level. World
> net worth has dropped something like 50%, an amount that dwarfs the
> amounts actually "created" by central banks. We are in a deflationary
> spiral that show no signs of stopping.
> When prices finally stop going down we'll have assets worth a fraction
> of their former value and many times the corresponding money supply.
> That will be a recipe for inflation, but from massively deflated
> values and prices.
> Until then cash (and gold) are king. Once the inflation starts, then
> you'll want to switch to commodities (and gold).

2009 Mar 22 02:29 PM