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
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
In the worst economic climate since the Great Depression, and
after the largest housing bust on 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
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
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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inherent dangers they pose for the U.S. economy and U.S. dollar, read Peter
Schiff's 2008 bestseller "The Little Book of Bull Moves in Bear
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Senior Market Strategist
Pacific Capital, Inc.
Acacia Street, #200 Newport Beach, CA 92660
888-377-3722 / Direct: 203-972-9300 Fax: 949-863-7100
all the other articles written by John Browne
more in-depth analysis of our financial problems and the inherent dangers
they pose for the U.S. economy and U.S. dollar, read Peter Schiff's just
released book "The Little Book
of Bull Moves in Bear Markets." Click here to order your copy now.
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John Browne is the
Senior Market Strategist for Euro Pacific Capital, Inc. Mr. Brown 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 Brown'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
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.
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