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How is massive inflation not eventually inevitable?



November 10, 2008 – Comments (13) | RELATED TICKERS: UDN

I was thinking about the current economic situation on the drive into work this morning.  Playing with some rough, back-of-the-envelope type of calculations in my head I decided that massive inflation is inevitable in the United States.  Yes, I know that everyone from consumers to hedge funds to investment banks is going through a massive deleveraging process which will certainly be deflationary near term. 

However, the value of a country's currency ultimately determines how much one can buy with it and in turn its rate of inflation.  In order for a currency to have value, there has to be demand for it.  The U.S. government is spending money at the fastest rate in history to bail out everyone on Earth, from investment banks, to AIG (again), to the automakers (this hasn't happened yet...but mark my word it will), and so on.  In addition to this there will likely be another huge stimulus package.  The Democratic idea of pay go is completely dead.  This means that the U.S. is going to have to create a massive amount of debt to finance all of this spending.

Here comes the rough calculation part.  Ignoring the elephant in the room, Social Security and Medicare, the U.S. national debt (after backing out trust finds) currently sits at between 5 and 6 trillion dollars.  This is already the highest percentage of the country's GDP since the 1950s.  I expect that to grow by at least 2 billion through the remainder of 2008 and all of 2009 (not to mention the fact that GDP will likely fall).  This will easily put the U.S. debt at its highest level since World War II.  The difference is, over the past 50 years there has been a dramatic shift in who buys U.S. treasuries from our "friends" like Germany and Japan to countries that the U.S. has a much less stable relationship with, like China and Russia.

China been one of the largest foreign buyers of U.S. debt, but it was doing so to finance our purchases of its cheap exports to the United States.  As our consumption of Chinese goods falls, and China spends its reserves to prop up its own economy its desire to purchase future U.S. debt will wane.

Once the "flight to safety" trade is over and the demand for dollars to settle trades slows I can't envision any situation where the value of the U.S. dollar doesn't begin to slide once again.  The question is in relation to what?  After initially underestimating the extent of the problems in the EU economy (and its stability), I personally am not a big fan of the Euro.  Perhaps the dollar will fall in relation to the Yen (the unwinding of the carry trade has certainly helped it).  If China can right its ship, perhaps the Yuan will rise versus the U.S. dollar.  Certainly once the global economy stabilizes at some point in 2009 or early 2010 commodities that are priced in U.S. dollars, like oil will eventually begin to rise.

I'm just sort of thinking aloud here.  Blogs are good for that.  Can someone explain to me how the U.S. dollar will remain strong?  Is the only bull case for it that it is the only game in town because everyone else in the world is as messed up as we are and there's no where else to put money?


13 Comments – Post Your Own

#1) On November 10, 2008 at 9:28 AM, TMFDeej (97.61) wrote:


Tied into the reduction in demand for the U.S. dollar and its drop in value, I don't see how interest rates won't eventually head significantly higher as the United States is forced to pay higher rates to attract capital.


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#2) On November 10, 2008 at 9:42 AM, kaskoosek (30.22) wrote:

It is enivitable.


Higher rates are on the way except if the Central bank starts buying government bonds directly. This could be possible with a chage in legistlation, but no sure.

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#3) On November 10, 2008 at 9:59 AM, outoffocus (23.91) wrote:

Honestly I've been asking this question for years. Also, with the amount the debt rising and the amount of income to service that debt falling, how on earth does the US Government still have a AAA rating on its debt?  If it were any other corporation with the same financials, the debt would barely be investment grade.  The rating agencies are already in enough trouble as it is for rating crap securities as AAA, now they are going to get in trouble for fraudulently rating the most widely held security of all, US treasuries. This why a portion of my portfolio is in commodities. I personally think this new "strength" in the dollar is all a facade and will be uncovered shortly.  Unfortunately, the next administration will take all the blame for it. 

Especially if they continue the reckless bailouts and other pork spending of late. The ONLY solution to this problem is to:

1. raise interest rates, something that is so much like right that I dont see it happening anytime soon,

 2. cut spending, and i mean REALLY cut spending, something I ALSO dont see happening anytime soon, we as americans have become too comfortable and complacent to make any sacrifices for their own country, and

3. raise taxes, that I see happening in the new administration, but I foresee the raises to be slow and subtle, certainly not enough to offset the increased spending we'll see over the next couple years. 

Honestly, I'm all for the "change" argument and I think, in the right environment the new administration could enforce all the changes in the aforementioned paragraph.  But I think the new administion will be hindered in its reformed because you have one man having to answer to 300 million whiny, complacent, spoiled americans that wont even sacrifiice a cheeseburger, let alone any of the sweat, finances, hard work, and lifestyle changes needed to get this country back on track.

Therefore, in the near term I'm very bearish on the US economy.  It will take some true economic pain for Americans to wake up and change their lifestyles.  The sacrifice will be forceful rather than voluntary.  But as the saying goes, you reap what you sow.

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#4) On November 10, 2008 at 10:29 AM, XMFSinchiruna (26.55) wrote:

So true! :)

We are building a weimar republic, and the indications coming out of the G20 meeting suggest it will be a global weimar republic... and since the USD is the "reserve currency of the world"... guess which currency will be hardest hit.

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#5) On November 10, 2008 at 10:31 AM, dangerfairy (< 20) wrote:

It probably is. But look out for deflation first (especially you Peter Shiff). This unwind isn't done yet.

The worst possible scenario is about to happen. Deflation followed by massive inflation, rendering the dollar useless.

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#6) On November 10, 2008 at 10:44 AM, BigFatBEAR (28.45) wrote:

Honestly, I feel like outoffocus' suggestions would tip us into depression territory rather than deep recession territory. Tight monetary and fiscal policy were what made the great depression so bad. It wasn't until the New Deal (and eventually WW2) that gov't spending and job creation pulled us out of the funk.

I think these steps are all necessary, but perhaps gradually and in a year or so, when we better know where the economy is headed. Plus, it would be political suicide for Obama to try all of this from the outset (not to mention he has no control over interest rates, unless Bernanke's bribe-able).

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#7) On November 10, 2008 at 10:48 AM, mrindependent (42.53) wrote:

In recent months we have seen a massive injection of currency into the system.  This injection of currency was used to offset the fact that many people have been building cash reserves due to uncertainty in the economy.  As uncertainty decreases cash will flow back into the system creating inflationary pressures.  The way massive inflation can be prevented is if the Federal Reserve tightens the money supply to offset the money that private citizens pour into the system.  I believe the government will be somewhat successful in this endeavor and will avoid hyperinflation. 

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#8) On November 10, 2008 at 10:51 AM, BigFatBEAR (28.45) wrote:

I'm as wary of runaway inflation in the US as the next guy, but right now the evidence just doesn't point that way to me. If you TRULY believe that hyperinflation is inevitable, wouldn't you be buying all the gold/silver/stocks/real estate/whatever you could with your cash, just to use it as a store of value?

The weakness in gold price has me thinking that something's afoot, and that something is most likely that investors are betting against hyperinflation.

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#9) On November 10, 2008 at 11:32 AM, outoffocus (23.91) wrote:

Bigfatbear, as far as the weakness in gold is concerned, you are right that something is afoot, but once again it is a facade.  The hedge funds helped drive up the price of gold way before its time, now that the hedge funds are unwinding, its causing gold as well as other commodities to "overcorrect".   Under normal circumstances if you saw this kind of price action in commodities it would be safe to say that investors are betting against hyperinflation.  But I highly doubt that "investor" sentiment is controlling the market at the moment. I will even venture to say that most "investors" are hanging on the sidelines waiting for the markets to settle before they make any real bets.


Also, I believe Deej pointed out that the current deleveraging is deflationary.  So, of course as the economy continues to deleverage, it would be best not to ratchet interest rates up to 10%, but I also think it is foolish to leave them at 1% for too long. If no one is borrowing, then what is the point of leaving interest rates so low? Also, banks are in need of capital. Well if a bank wants my capital they need to be willing to pay for it.  (see my blog  on this subject entitled  Raise Interest Rates?) So in the short term, I say the government needs to let things be, but in the long term, we need to tighten our belts or we're going to be in big trouble.

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#10) On November 10, 2008 at 11:36 AM, RVAspeculator (28.39) wrote:

My post last night was saying the same thing....  Deflationists will be in for a suprise.

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#11) On November 10, 2008 at 12:13 PM, darksabre (59.97) wrote:

I think the deflationary forces has a bit a way to run out before we even worry about inflation.  I give it a few months still.   Even after today's involvement of China, markets have fallen quickly from opening.  People, Funds and everyone in between are selling without any regards to fundamentals.  I grant that some companies are having their earnings overtly optimistic, but if the Market is selling like crazy, the deflationary forces are going to still exist for a little longer. 


So the question is how to take advantage of the eventual inflation?  Over long term, US $ will come back down - massive debt and global stability (eventually) will make sure of it.  But if deflation is here and all asset classes are falling, then even commodities are subject to unknowns in their asset values, no?


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#12) On November 10, 2008 at 12:23 PM, bhessel (40.27) wrote:

Deej, here is the best argument I have seen in favor of a multi-year bull market for the dollar.

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#13) On November 11, 2008 at 1:13 PM, edbbear (< 20) wrote:

This is what I'm trying to figure out.  I just sold half my stake in GLD today, taking a loss because it keeps on trading with the stock market.  It's frustrating because there's a discrepancy between futures and cash trades.  You can't get physical gold right now, the demand is too strong, yet GLD is taking a bath.  I just can't see it not continue to go down in the near future as the economy continues to struggle and money flows out of the markets. 

But at some point I think hyperinflation has to kick in.  The government is printing money left and right to get out of this problem.  At some point it's going to come back to haunt us. 


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