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what is the potential source of inflation: Independent investment advice


     Investors have asked about the possibility of the return of inflation because it can severly damage bonds and also hurt stocks.

    Inflation is nurtured by an increase in the money supply but can only occur if there are constraints or bottlenecks such as a labor shortage or powerful unions or restrictions on imports. Since these things are not happening then inflation will remain subdued.

    The three potential sources of inflation:

  1. Consumers and corporations borrow more from banks. This is not likely since only healthy people and corporations can qualify for a loan and they don’t want to borrow.
  2. The Fed monetizes the Treasury’s debt. This needs Congressional approval. With ever increasing deficits projected into the future surely more voters will insist on electing Congress members who would try to reduce the deficit. Do you really think the government will meekly pay all of its contingent liabilities when they come due, assuming these are 500% of GDP? Instead Congress will simply refuse to pay. It would not help the government to create inflation because many of the government’s cost are sensitive to inflation so causing inflation in order to pay for the government’s expenses would quickly be seen as something that does not benefit the government.
  3. Quantitative easing, done to devalue the currency, will not work because other countries will negate that by doing competitive devaluations. Further, if the U.S. did devalue by 20% that would affect the 17% of goods that are imported, which would be a one-time 3.4% additional increase in inflation. Regarding devaluations, the dollar has dropped 15% in 30 years or half a percent a year, which is less than inflation.

    I have written about this here and here. This is an example of independent investment advice.


I'm not an expert by any means but it seems to me that your #3 has already occurred. The US dollar is at historic lows versus the yen and as low as I can ever remember it against the Canadian dollar and others. The QE2 is being monetized as we speak. And for all of the saber rattling in Washington, the debt continues to grow at an unsustainable pace. 
Feel free to correct my errant thinking.
Posted @ Wednesday, May 18, 2011 8:58 AM by Eric
Thank you for your comment. I posted my reply on today's May 18, 2011 blog post.  
P.S. Yes I agree government debt is growing too much, but that is a separate topic from QE II causing devaluation.
Posted @ Wednesday, May 18, 2011 4:58 PM by Don Martin
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Donald Martin, CFP®

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Donald Martin is a NAPFA-Registered Fee-Only financial planner and investment advisor.