 Inflation by
Stealth
John Browne
Oct 29, 2009
So for now, inflation is
like a ninja stalking our economy. It's lurking in the shadows
but can't easily be seen. But once its strikes, it will be fast
and deadly.
Over the past two years, the
federal government and the Federal Reserve have dispersed trillions
of public dollars, run up enormous deficits, and kept interest
rates at zero. In just about any economic textbook, this combination
of policies would be described as the perfect recipe for inflation.
Yet, with the exception of the usual increases in health care
and education, prices by and large are not rising. Many have
concluded that our economic leadership has simply outsmarted
the textbooks.
The benign CPI figures are
serving as a rallying point behind which the financial talking-heads
are forming a parade of optimism. The low CPI is their 'proof'
that inflation is not a pressing concern. This view is two dimensional.
Inflation is classically described
simply as an increase in the money supply. Although these changes
will impact price levels, it doesn't necessarily follow that
prices will rise when inflation is high. Instead, inflation may
merely result in stable prices at a time when prices would otherwise
be falling.
In the popular mentality, however,
inflation is simply defined as prices rising. After decades of
steadily rising prices, people seem to have forgotten that prices
sometimes fall. In light of the bursting of a number of record-breaking,
government-fueled asset bubbles, prices should be declining across
the board (as they did in the Great Depression). The fact that
prices are stable, or have even rallied in some sectors, indicates
that inflation is already spreading across the economy.
After falling to just 6,547
in the months after the crash, the Dow has rallied past the 10,000
mark. This should strike even novice investors as unjustified.
Jobs are still being lost, a massive healthcare entitlement and
carbon tax are winding through Congress, and no one with at least
one foot in the real world has a palpable sense of imminent recovery.
Corporate earnings have fallen far behind the rally in shares
prices, stretching valuation multiples to pre-crash levels.
While not quite as frothy,
home prices are now moving up for all the wrong reasons. The
seminal Case-Shiller Index of home prices is now up for the fourth
month in a row. The index's designer, Professor Robert Shiller,
has stated recently that the current upward trajectory is unsustainable.
In fact, the levels are still above the 50 and 100 year trend
lines.
In the worst economic climate
since the Great Depression, and after the largest housing bust
in memory, single-family home prices should be falling
well below the trend lines. But with a doubling of the monetary
base and special interest programs like the homebuyers' tax credit,
home prices have stabilized and even increased in some markets.
That's the work of inflation.
With GDP growth now returning
to positive territory, many inflation hawks ask why inflation
has yet to truly manifest. The explanation can be found in the
difference between monetary base and money supply.
The latest $1.9 trillion injection
of government money was composed of some $900 billion of stimulus,
of which only about 20 percent has been distributed. However,
in its attempts to stabilize the financial system, the government
has already spent some $1 trillion of TARP-type funds.
The TARP money, financed by
an increase in the monetary base, has been provided to the banks
at zero cost. And for the first time ever, the Fed is paying
interest on bank reserves. Therefore, the banks can loan money
to the Fed and to the government, via Treasury securities, at
an interest rate spread of some 3 to 4 percent without risk.
Given these incentives, it makes no sense to loan to anybody
else. So, despite a massive increase in the monetary base, credit
remains tight and price levels flat.
However, if the Fed stops paying
interest on bank reserves or otherwise 'persuades' the banks
to lend, the $1 trillion will be leveraged up by the banks and
spewed out into the economy. Fractional reserve banking will
transform a $1 trillion monetary base injection into a $9 trillion
increase in money supply. When that happens, prices for everything
will go through the roof.
So for now, inflation is like
a ninja stalking our economy. It's lurking in the shadows but
can't easily be seen. But once its strikes, it will be fast and
deadly.
###
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John Browne
Senior
Market Strategist
Euro Pacific Capital, Inc.
1 800-727-7922
email: jbrowne@europac.net
website:
www.europac.net
 John
Browne is the Senior Market Strategist for Euro Pacific Capital,
Inc. Mr. Browne is a distinguished former member of Britain's
Parliament who served on the Treasury Select Committee, as Chairman
of the Conservative Small Business Committee, and as a close associate
of then-Prime Minister Margaret Thatcher. Among his many notable
assignments, John served as a principal advisor to Mrs. Thatcher's
government on issues related to the Soviet Union, and was the
first to convince Thatcher of the growing stature of then Agriculture
Minister Mikhail Gorbachev. As a partial result of Browne's advocacy,
Thatcher famously pronounced that Gorbachev was a man the West
"could do business with." A graduate of the Royal Military
Academy Sandhurst, Britain's version of West Point and retired
British army major, John served as a pilot, parachutist, and communications
specialist in the elite Grenadiers of the Royal Guard.
In addition to careers in British politics and the military, John
has a significant background, spanning some 37 years, in finance
and business. After graduating from the Harvard Business School,
John joined the New York firm of Morgan Stanley & Co as an
investment banker. He has also worked with such firms as Barclays
Bank and Citigroup. During his career he has served on the boards
of numerous banks and international corporations, with a special
interest in venture capital. He is a frequent guest on CNBC's
Kudlow & Co. and the former editor of NewsMax Media's Financial
Intelligence Report and Moneynews.com. He holds FINRA series 7
& 63 licenses.
321gold Ltd
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