Inflation creation machine is broken: independent financial advice

     Inflation can be created by three methods:

1.      An increase in the money supply combined with tight labor markets and minimal excess capacity

2.      Monetization of Treasury debt by the Federal Reserve

3.      Quantitative easing, done to devalue the currency

     None of these three can happen in the next few years. There is a huge amount of slack and excess labor capacity in the U.S. The only way to reduce unemployment is to increase jobs by 300,000 monthly for several years, a rate that has not happened consistently since the boom years of the 1990’s. This potential type of inflation is what happened in the 1970’s and is the most important type to be alert for.

   Monetization of the Treasury debt will only happen if the Treasury can’t sell its debt to anyone. This would only happen if the Congress authorized a huge increase in spending. Huge deficits are forecasted in the distant future, but as we get closer in time to those years there will be more pressure on Congress to refuse to authorize huge deficits. Also there are very special reasons why foreign countries will continue to buy Treasuries.

    Quantitative easing has failed. Its goal was to increase the money supply but the bank reserves it created were hoarded as cash by banks; instead bank lending actually shrunk. The velocity of money plummeted by 50% during the 2008 crisis and has remained at a low level. Its goal is also to devalue the currency but foreign countries will try to set an artificial rate for their currency so that they engage in competitive devaluations (currency wars) that prevent the Fed from devaluing the dollar.

    I have written about this before “What is the potential source of inflation?”

     Ask yourself what if the stock market and China’s economy are a bubble that crashes? What will happen to commodities? Will a “flash crash” cause a wave of selling that results in margin calls which trigger more selling? What about the small investors who write naked Puts to earn some extra money, will they lose their nest egg, and if so will the VIX be a prohibitively high level that would make hedge funds unable to invest with extreme leverage? The market is propped up by a low VIX and low margin rates that fuel asset bubbles. These bubbles are unsustainable and subject to a sudden crash. A risk asset (stocks, real estate, commodities) crash will make investors flee into Treasuries. This is an example of independent financial advice.

2017-01-10T23:32:32-08:00 April 15th, 2011|mayflowercapital blog|Comments Off on Inflation creation machine is broken: independent financial advice

About the Author:

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Donald Martin has a B.A. in Accounting and M.B.A. Finance, and has passed the rigorous CFP® exam and met the experience requirements needed to become a CERTIFIED FINANCIAL PLANNER™ professional. He has been employed in the financial services industries for 30 years and has been investing for his own account for 38 years. Donald Martin’s 19 year career in lending prepared him for fixed income analysis, Securities analysis, and macro-economic analysis used for investing. Donald Martin founded Mayflower Capital in 1993 to provide independent financial advice and implementation of advice about loans. In 2005 Donald Martin changed the company’s mission to providing independent financial advice about investments and financial planning and stopped providing loan services. Donald Martin has a B.A. in Accounting and M.B.A. Finance, and has passed the rigorous CFP® exam and met the experience requirements needed to become a CERTIFIED FINANCIAL PLANNER™ professional. He has been employed in the financial services industries for 30 years and has been investing for his own account for 38 years.