Guest Post by Monty Pelerin
The issue of inflation versus deflation should not be a discussion of debate. The proper definition of inflation is an increase in the money supply. By that definition, there has been massive inflation since 2008.
The bastardized definition of inflation, the one that is most commonly used by layman (and increasingly by economists) deals with the rate of price changes, typically as measured by some index like the Consumer Price Index. According to this government-issued report, inflation is not a problem. Some (many?) believe this index is motivated for political purposes. John Williams is one who has studied this series and he claims it is grossly understated.
There are both political and fiscal incentives to understate inflation, however those are not going to be discussed here.
The unusual divergence between money supply and price increases is baffling. The government is undoubtedly shaping reports on inflation (and other politically sensitive measures). However, the size of this divergence cannot be explained by such chicanery. Excess reserves in the banking system may explain a big part of the issue. Apparently there are about $2.5 Trillion of reserves that could be lent out. These reserves represent “high-powered” money, which means when it is lent out it will generate another $25 Trillion in circulating money. That would cause inflation to explode, perhaps even trigger hyperinflation and a complete collapse of the dollar.
There are two problems here:
- This money is now outside of Federal Reserve control. It is now “owned” and controlled by individual banks in the banking system. Should demand for lending improve (i.e., should the economy begin to recover), Katie bar the door.
- The Fed recognizes this danger but cannot do anything about it. There is no apparent way that they can get these reserves back. Their balance sheet is worse than the composite banking system’s balance sheet.
Even with the manipulations at work, there are some ominous signs that price inflation may be breaking out. Anyone who buys groceries identifies with that, however that is an imperfect measurement as we tend to imagine what we want to see. Food prices clearly have risen dramatically, but a broader index is a safer way to measure whether inflation is becoming an issue. A reader, NII, sent this email which I believe shows the increasing danger:
WHO DO YOU BELIEVE? THE COMMODITY INDEX OR U.S. LONG TERM INTEREST RATES?
LMN: In contrast to the FOMC view, there are very mixed signals about inflation or deflation right now as we’ve highlighted before. On the one hand, the Continuous Commodity Index is up 9.6% ytd, while on the other, Treasury yields have fallen sharply and yield curves have flattened considerably.
NII: The huge increase in Belgium’s Treasury holdings since October 2013 as longer term yields decline suggest “non-market” forces are helping to determining Treasury yields.
ZH: Belgium has added a record $141 billion in Treasurys since December, or the month in which Bernanke announced the start of the Taper, bringing the host’s total to an unprecedented $341 billion.“Belgium” bought another $40 billion in March.
Who has bought a whopping $200 billion in Treasuries using Belgium as a proxy since October?
The last question is an interesting one but can only be speculated upon. Very few countries are clamoring for our Treasuries. In fact, I can think of none. The numbers above are huge, which rules out all but the largest economic players. I don’t have an answer, but it is obvious that the buyer does not want his identity known for some reason. Our friends and allies are unlikely buyers. Europe has problems at least as big as ours. Russia and China are not friends and have been not acting that way. They already have over-large (in their view) amounts of US debt and appear to be sellers rather than buyers.
We are almost out of candidates. Japan is a possibility but they too are over-stocked with US debt. Furthermore they have enormous economic issues. So, who else is left? Could it be the US itself? Is this another devious attempt to keep the music playing? It seems to be the most plausible answer, although their is no evidence to back it up. But that is the point!