Everyone We Know Expects a Fairly Quick Up-move in Inflation

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Poor Dermot Gleeson. The Irish economy is sinking…led by its banking sector. This makes bankers the most despised of all the Irish…and made Gleeson the target of egg-tossing shareholders at the annual meeting last week. The chairman of Allied Irish Bank had to dodge eggs while getting his message across – whatever it was. Warning to America’s bankers: get ready to duck.

So where’s the surprise for us? What’ll it be? Japan or Zimbabwe? We’ve already said we’re expecting both Japan and Zimbabwe. What else could it be? And we’re ready for them both.

Well, needless to say, we’ll be surprised like everyone else. And needless to say, we don’t know what will surprise us. But we have an idea. Almost everyone we know is expecting a fairly quick up-move in inflation. Our guess is that that up-move might be a long way off.

“It’s a very funny and troublesome situation,” said a fund manager in Boston last night. “The world’s central bankers are committed to a policy of monetary inflation…which they call ‘Quantitative Easing.’ And they believe that inflation targeting is the way they can tell if their policy is working. That is, they believe they will know when to stop inflating the currency by looking at consumer prices. When consumer prices begin to rise, they’ll be ready to stop adding to the money supply. In fact, they say they’ll then turn the machine to reverse to take out the extra cash they’ve added.

“So, they’ll keep at it until the CPI goes up. But by the time they see consumer prices rise, it will be too late. By then, people will be eager to spend…to get rid of dollars. And once they begin to spend again, the velocity of money will go up. And with it, inflation rates will go up higher…and then dollar holders will want to get out of bonds quickly…because they’ll see the next move too – a drop in bond prices.

“Well, how could the Fed combat this rising inflation? And prices could be rising very, very fast. It would have to go back into the market and sell those bonds that it bought from the Treasury. Selling the bonds would have the opposite effect as buying them. Instead of creating money with which to buy bonds, it would re-absorb money when it sold them. People would pay money for the bonds…and the cash would be sequestered by the Fed.

“So, you’d have the Fed trying to sell bonds just when everyone else was selling them. At that point, with the biggest bond buyer in the world turning into a seller, the Treasury market would collapse. This would paralyze the Fed. It might want to sell Treasuries. But, under the circumstances…with yields soaring and prices crashing…it wouldn’t be able. So all the inflation that it put in the system would have to stay there…and inflation would have to run its course.

“It’s very hard to know what to do as an investor. I guess in theory you should stay long treasuries…buy them as long as the Fed is buying. And then you should go short…sell them, just before the inflation numbers turn positive…and just before the Fed tries to sell. But that is going to be very, very difficult timing.

“I began buying gold for the first time ever last week.”

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
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Bill, I have also been pondering how the Fed will combat rising prices when it commences myself. Like you I have deduced that the Fed may be the last buyer (in quantity) left standing for USG debt hence it cannot sell those. Everything else on its balance sheet is subprime so who is going to buy that? The only option it has left is to increase the reserve requirements of banks and lock up the excess reserves in bank vaults. Of course it does not have to worry about this until credit starts expanding again in the private sector, and… Read more »
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