Tag Archives: us inflation

FOMC divided on when to end purchases

21 Feb

The minutes of the FOMC Jan 29-30 meeting show divided opinion on when to end asset purchases.

A ‘number’ of participants believe the costs of QE would materialize before the benefits, while ‘several’ participants argue that the risks of ending QE prematurely are very high.

End sooner?

The debate does raise important questions as an early scaling back of QE could materially affect a number of markets. Bond yields and mortgage rates are at or near historical lows, aiding businesses requiring financing and home owners who can refinance mortgages or purchase properties very cheaply. This ultimately helps drive a recovery in the housing market, a vital component to the health of the economy . Equity markets have also rallied significantly, boosting consumer confidence and sparking a revival in M&A, as seen recently by Mr Buffet’s recent acquisition of Heinz.

Maintain asset purchases until unemployment drops?

The ‘cost’ of QE, raised by a number of the committee, refers to the impact on future inflation that printing money is likely to have.

US inflation at 1.7%, at first, should not cause great concern. But the FOMC participants know how quickly expectations can change if central banks are seen to be irresponsible with regards to price stability, a significant objective of the Fed’s monetary policy.

It seems the Fed is stuck between a rock and a hard place and the debate will continue for some time yet. Participants will ultimately be forced to make the least worst decision.

Given Mr Bernanke’s lifelong focus on analysing the causes of the great depression, it would be a great surprise if the Fed did prematurely end asset purchases. QE, after all, is part of Mr Bernanke’s detailed and meticulous plan to ensure that we never return to the deflationary depression of the 30’s – Read here Bernanke’s 2002 speech.

His plan may well work, but at what cost?

Trust, hyperinflation and the end of the dollar

13 Feb

Economists love debating the reasons for inflation. Many argue that money supply alone can result in inflation, whereas others believe it is down to capacity constraints in an economy or advancements in technology. The reality is that the causes of inflation are immensely diverse and one reason is never the sole contributor, nor is there a unique common cause of inflation in previous hyperinflationary times.

Instead, hyperinflation is typically caused by a very severe exogenous shock, that then usually forces policymakers to take overly aggressive action in order to overcome their difficulties.

War, the collapse of regimes and currency pegs all feature as severe shocks in previous cases of hyperinflation. Clearly we have none of these yet, but the credit crisis was as close to a severe shock as one could possibly imagine. And how have policymakers responded? Br printing money. We are now 5 years into the crisis and the rate a which central banks globally are printing money is only accelerating.

So why haven’t we seen hyperinflation yet?

It takes time. For the last 40 years Monetary supply in the US (M2) has been growing at an average pace of about 6.75% a year vs. average annual inflation of 4.3%. Clearly the increasingly efficient economy and advancement of technology of the past 40 years have been deflationary enough to keep the CPI below money supply. John Edwards, of Shadowstats, argues that M3 is a better indication of inflationary expectations but sadly the US stopped reporting this some years ago.

m2 and cpi

In any case, if we overlay the monetary base chart over the M2 chart, it is clear that 4 years ago these decoupled SUBSTANTIALLY! This is the effect of QE which has essentially flooded the US monetary base with newly created dollars. It takes time but this will eventually feed through to M2.

monetary base and m2

As it does feed through, prices have to re-adjust (i.e. rise) as people’s perception of the value of that currency diminishes. As trust in a currency’s value disappears, so do people’s willingness to hold onto it, opting instead for alternative currencies or real goods such as property, gold etc, once again compounding the effects of rising prices. And so the spiral goes.

I have no doubt the FED intends to halt QE before we get close to this. But as every episode in history has suggested once the floodgates are opened it is very very difficult to close them again.

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