Independent Investment Advice Blog

what is the potential source of inflation: Independent investment advice

Posted by Don Martin on Mon, Mar 07, 2011 @ 10:09 AM

     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.

Tags: independent investment advice, QE2, inflation

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