bearfund

The Bailout Pork Effect: Short Term Rally, Long Term Disaster

Those of you insisting that long-term deflation is a certainty and commodities are headed to zero are committing one of the cardinal sins: you are fighting the Fed.

Interest rates will go lower, for starters. Even the futures market finally agrees with me, though no one can be certain of the exact timing. Multiple pundits are now predicting 1% or even 0% as the cycle low. Then there's another little item in the bailout. The real reason the Fed wants to pay interest on reserves isn't that it will help manage the Fed Funds Rate during liquidity crises (though it will) but rather that the interest paid is a direct and immediate increase in the money supply. There is no way the Fed can sell Treasuries to offset the interest they pay; they don't have any left. So right there you have a nice source of monetization. The real channel for money creation, however, will now be from the Fed through the Treasury and thence out multiple channels: the multiple bailout funds, new bailout loans, and especially more "fiscal stimulus" which will amount to nothing more complicated than printing money and dropping it out of helicopters (minus the physical printing and the helicopters). They will continue to hand out money to those whose finances and/or behaviours match those they favour; it may take the form of free medical care (money flows from the Fed to the Treasury to hospitals through their staff and out into the economy while the money that used to go there now remains with corporations and individuals who no longer need to pay for medical care). It may take the form of more "rebates" which work in obvious enough ways. We already have extended unemployment benefits; there may be more of that. And it would not surprise me if widespread "infrastructure investment", once discussed widely before the crisis stole the headlines, gets under way. Some of the projects might even be good investments, though the real purpose will be to reward loyal contractors and Congressmen with porky deals and get money flowing into the economy, not make a long-term improvement in American competitiveness (and that's a shame, because if done properly such investment not only sterilizes the money but also delivers real returns - see WPA).

The bottom line is that Helicopter Ben was dead-right. There will be no deflation. However deep the recession, you can be certain that more money will be printed and that prices will rise. Whether it will help to end the recession will be a topic for argument in economic history papers, but that it will cause prices of basic goods to rise is unquestionable. The market for such goods is global, and price controls are ineffective. If you are printing money and other governments are not, you will have to offer more of your currency to outbid the rest of the world for commodities. And if everyone is printing, the price will simply rise with the money supply: the supply of the commodity is only so great, it changes slowly, and demand for life essentials has a clear floor. There is no way to avoid this fate when you print money.