Inflation Ahead?

The Market Ticker has a very interesting report. From August 6th.

Remember the Dallas Fed's Fisher saying that "The Fed will not become the handmaiden of Treasury"?

He was lying (The Fed already has), and now there is proof.

Mad props to both Zerohedge and Chris Martenson for noticing this; I missed the facts buried in the CUSIP list.

The upshot: The Fed bought nearly half of LAST WEEK'S 7 year Treasury Issuance TODAY.

Huh? Remember, after the 5 year auction that went badly (and which I wrote about) the 7yr auction went "well." Rick Santelli (and a lot of other people) agreed - demand was strong. That made no sense to me at the time, coming one day after a near-failure in the 5 year.

Well now we know what happened: The Fed pretty clearly pre-arranged, either explicitly or by "suggestion", that the Primary Dealers take up the auction with the promise that The Fed would immediately monetize half what the Primary Dealer's took!

Folks, this is beyond bad - it is pernicious and outrageous conduct by The Federal Reserve in conspiracy with the Primary Dealers, both of which are now desperately trying to prop up the US Government Bond Market through subterfuge rather than just buying up the bond issue from Treasury when originally put to the market!

If you think the economy and credit markets are "on the mend" why would The Fed do something like this? It would not be necessary unless The Fed was told (by those very same Primary Dealers) that they were going to be unable or unwilling to take down any more Treasury Debt.

Folks, let me be clear: The United States HAS OFFICIALLY HIT THE TREASURY DEBT WALL and The Fed and Treasury are engaged in subterfuge and conspiracy in an attempt to hide this from the market.

What this means is that the dollar's value is much less than what it was last week. If it is true. Or to put it another way. The government in the last 6 months has stolen a nice fraction of your money. As of today you are broke and don't know it.

There are two ways to protect yourself. Buy hard assets or go into debt.

It may very well be Wiemar Republic time. And you know what follows that.

Cross Posted at Power and Control

posted by Simon on 08.08.09 at 12:09 PM





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Buy hard assets or go into debt.

About the only hard asset that the average person can finance is a primary residence.

Perhaps this is the only thing proping up the housing market?

It's all monopoly money now.

ThomasD   ·  August 8, 2009 02:47 PM

I'm having a hard time making sense of this, or why it is a problem. We already know that Social Security holds half of the total debt of the United States; the Social Security reserves that have been amassing over the past several decades have been held in treasuries. So the fact that the government would go and buy treasuries from the government--that's standard operating procedure.

The hyperbole that China and Japan holds the debt of the United States understates the total public debt (which is half of the overall debt) that is held by other nations and by U.S. citizens. Don't get me wrong; if China decided to dump their holdings it would affect the bond market--but the total amount they're carrying amounts to a fraction of what Obama just spent this year.

I'm also concerned by inflationary pressure as well, but at the moment we're in danger of deflation, not inflation--so the excess debt is currently not triggering a macroeconomic event. (My concern has to do more with if the economy starts recovering, that will create inflationary pressure--and if the government continues doing then what it is doing now, we may get out-of-control inflation. But for the moment, even factoring out the WalMart effect, we don't seem to be in danger of short-term inflation.)


I'm not saying the report is wrong--but the signal to noise of the linked articles is kinda high, and I don't understand specifically the macroeconomic issues he's alluding to. They don't make any sense given my current (albeit only average) understanding of the way the Fed and Treasury have historically worked.

William Woody   ·  August 8, 2009 04:19 PM

WW,

Monetizing the debt is inherently inflationary.

For SS the government takes money out of the economy and issues bonds. What is going on now is issuing bonds and putting money into the economy.

Production is down - money supply is up. Inflation is a sure thing.

BTW correction of a bubble requires deflation. Assets were bid up beyond what the economy could support.

Let me add that we are in a secular decline. The really big gains from computerizing everything are gone. There are still gains but they are hard to come by.

We are not too bad off. Decline in demand means that the least efficient production eqpt. will be scrapped. Old factories will be shut down. When demand grows again new eqpt. will be the most productive.

So what do we need? Some new thing capable of throwing off huge profits. A lowering of power costs might do it. Polywell Fusion for instance.

I don't see anything on the horizon. In 1977 I saw the economic future of the microprocessor (I saw the technical future in 1975). I don't see anything now.

M. Simon   ·  August 8, 2009 05:35 PM

Production is down - money supply is up. Inflation is a sure thing.

All things being equal (and that includes the velocity of money), when the money supply goes up, inflation is a sure thing. But all things are not equal, right? And the sure measure of if inflation is now taking place is the consumer price index, and the sure measure of long-term thinking on inflation are the futures markets. And they're saying everything will be flat, at least for the foreseeable future. (Don't get me wrong: I refinanced my home recently on the belief that in two to three years we could likely see high single-digit inflation triggered by a recovering economy and a government used to printing too much money. I'm hedging my bet that there will be inflation in the medium to long term.)

The velocity of money is definitely down: the government may be printing money like there is no tomorrow, but it seems to be going into long term savings rather than into circulation. Given an impending collapse of the commercial real-estate market, it could be banks are hedging their bets against that collapse.

But getting back to the topic at hand, I don't understand the articles that are accusing the Fed, Treasury and primary dealers of some sort of malfeasance in the last bond auction, because the Treasury bought bonds. The Treasury always buys bonds, to fund Social Security--so I don't know what has supposedly changed in order to show that somehow the rules are being violated or the game rigged. What would worry me is that short- and long-term treasury rates would go through the roof: if the supply of treasuries is greater than the demand for treasuries, the government is going to be forced to pay more interest to sell those treasuries. Sky-high bond rates would hurt any sort of recovery, since it would capture more and more private investment money and take it out of circulation for private capital investment. And that would restrict growth.

If somehow the Fed and Treasury were in collusion to prevent the saturation of the bond market in order to keep interest rates low, I would consider this a good thing, in that the government would be hitting the limit of what they could borrow, and would be forced to not spend money where it has been budgeted. If they allow bond rates to jump in a recessionary environment, we'd have a double-dip recession (and we may get one anyway), which would kill any chance of recovery.

In other words, if they are engaged in some sort of attempt to keep bond rates reasonable rather than allow them to jump, while it may piss off China, I would see it as the ultimate economic veto of Obama's grand plans for government growth.

William Woody   ·  August 8, 2009 07:53 PM

Woody,

Typically inflation shows up 12 to 24 months after an inflation of the money supply. So the fact that the markets are not currently factoring in inflation is no surprise.

And I do believe we will see a double dip. Instead of taking our licks the government is trying to reflate the bubble. For the time being real estate is out. So where will the money go with the treasury passing out paper? I think your mention of paying off debts is about right.

I also agree about commercial real estate. That one will be unwinding over a longer period of time as commercial renters go belly up.

M. Simon   ·  August 8, 2009 08:25 PM

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