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It’s Baaaaaack (Cue Creepy Music)

It’s time to roll up our sleeves, put on our waders and plunge into the inflation-deflation question once again. It’s going to get messy. But it’s probably the most important question to answer for investors right now. That’s because the price direction of almost every asset on the planet depends on these monetary forces.

What prompted us to tackle this bug bear now? Why aren’t we out on a Buenos Aires terraza sipping cold beer instead? Well, we couldn’t help noticing that the yields on long-dated US Treasuries are rising.

As underground investors Adam Lass writes in today’s Taipan Daily, last December future contracts for 30-year T-Bonds “were hovering around 142 and change with yields under 2%. Now we were looking 122, a drop of some 14%, forcing yields to just about double.” And last week the 10-year Treasury bond yield, which hit 2.07% in December, broke above 3% for the first time since the financial crisis started last September. It is currently trading at around 3.17%.

For those of you not familiar with the relationship between Treasury yields and inflation, higher yields on long-dated bonds is a sign that the bond market is anticipating higher interest rates in the future. (Higher interest rates being the typical monetary response of central banks to higher inflation rates.)

What could be pushing up pushing up yields on long-dated T-bonds? Look no further, dear reader, than the frantic action of the wonks at the US Federal Reserve.

This from Martin Hutchinson at Money Morning:

Monetary policy has been extremely stimulative for the last six months, with broad money growth running at more than 15%, and real interest rates substantially negative. The justification for this – that the United States was in danger of substantial deflation – was proved to be erroneous by last week’s report on first-quarter gross domestic product (NYSEMKT:GDP). In that report, the deflator – the rate at which domestically produced goods increase in price – was a surprisingly high 2.9%, indicating that inflation has by no means gone away.

In addition, the U.S. Federal Reserve is buying securities in the markets and financing others to do the same; its purchases of U.S. Treasury bonds, in particular, are nothing more than a pure monetization of the U.S. federal deficit, which can only lead directly to higher inflation.

As Martin points out, the German Weimar Republic did something similar. In the years leading the one trillion percent inflation of 1923, monetized 50% of government expenditure. The Fed isn’t that stupid, of course. In buying $300 billion of T-bonds in six months, it is only monetizing about 15% of government expenditure… Of course, as more pressure comes to bear on the Treasury’s bond auctions, the Fed may have to up its monetization efforts.