Yes, Virginia, there is a Santa Claus…
By: BJ Lawson
… his name is Ben Bernanke.
Headline from CNBC:
Credit Watch: Fed to Pump More Funds Into Markets
The U.S. Federal Reserve and European Central Bank announced plans to pump more funds into troubled money markets to give banks enough cash to get them through a year-end squeeze.
Persistent concerns about banks’ year-end funding drove up interbank rates and the Fed said it would put enough funds into the money markets into the new year to resist upward pressures on its benchmark interest rate, the fed funds rate.
Seriously, folks, this story is not news. Failure of the Fed to “pump more funds” into money markets to manage the fed funds rate would be news. You see, the Fed has two choices:
- “Inject liquidity” (i.e., create money) as needed to ensure banks are willing to lend to each other; or
- Allow the banking system to seize up, cutting off credit to businesses, and potentially collapsing the entire system
In other words, “inflate or die.” Option (2) isn’t really an option, is it? So we just thank the Fed for their service, and accept the fact that new money into the system keeps things afloat for the time being.
But how is this situation a bad thing? Is this new money creation really an inflationary force, since it’s being done to offset the deflationary force of collapsing assets based upon troubled mortgages? Couldn’t the Fed get it right, and balance the deflation of the collapsing CDO valuations with the “right” amount of new money to keep rates and confidence at the appropriate levels?
In other words, what is REALLY going to happen? Are we going to see deflation (where money becomes more valuable, and most asset prices go down), since the collapsing CDO valuations haven’t begun to really gather steam yet? Are we going to see overall price stability, because the Fed will perfectly offset the CDO valuation declines with the “right” amount of “new money”? Are we going to see inflation, because the Fed’s incessant creation of new money to keep banks willing to lend will just further inflate a system that was already overwhelmed with liquidity?
These are overly simplistic questions, but they are at the heart of what many people are asking as they try to determine where to park their savings and investments during this turbulent time. If you expect deflation, you should be weighted towards cash. If you expect stability, you need to read more history. If you expect inflation, you should be weighted towards commodities and hard assets.
The trouble with expecting deflation in this scenario is that we are resuscitating this collapsing debt bubble in the midst of a $9.1 trillion (and growing) national debt and current account deficit of over $800 billion. You can’t just look at what is happening within the banking industry, you must also consider what is happening in our government, and between our country and our trading partners around the world. Just to keep the lights on in Washington, we have to borrow and print an additional $1-3 billion per day. That doesn’t seem like much, but eventually it adds up — to the point we’re adding to our national debt by about $600 billion per year.
Bottom line is that we’re creating an awful lot of new money, for a whole bunch of reasons. That’s a highly quantitative analysis, but the market’s verdict is pretty clear: our currency continues to decline on international markets, gold continues to hold above $800 per ounce, oil is over $90 per barrel, and my family’s grocery bill is way up assuming we try and maintain a constant standard of living. Objectively, that says we’re in an inflationary environment.
On the bright side, our currency is a fine medium of exchange — lots of people accept it as payment for lots of useful things. But when our fiat currency was born in 1971, price levels were about five times less than what they are today based upon the Bureau of Labor Statistics’ inflation calculator. So over the long term, it is an extremely poor store of value.
Santa, paper is for wrapping.