This is a visualization of what the Fed is doing:
The chart is from a Martin Weiss article dealing with Bernanke and Fed irresponsibility.
The current path is unsustainable and must be stopped. There are only three options according to Thomas Hoenig, President of the Federal Reserve Bank of Kansas City. Weiss describes the Hoenig’s three options,
Path #1 — Monetize. The government runs massive deficits and borrows without restraint. At the same time, the Federal Reserve monetizes the debt — finances it by running the nation’s printing presses. This is the path of least resistance for politicians … and of greatest danger to the nation.
Yet, unfortunately, as evidenced by the explosion in the monetary base illustrated above, it’s also the speedway down which the Fed is now racing.
Path #2 — Policy stalemate. As in path #1, the government runs massive deficits and borrows without restraint. But the Federal Reserve refuses to finance it. Instead, the Fed lets the natural supply and demand for debt drive interest rates higher.
Soon, the government finds it is too expensive — or nearly impossible — to borrow. And ultimately, Washington has no choice but to slash spending despite any near-term consequences.
This is what’s happening to many governments around the world right now — not only in Greece, but also in California, Arizona, New Jersey, Massachusetts, plus scores of other state and local governments across the USA. In the final analysis, Washington cannot avoid a similar day of reckoning.
Path #3 — Fiscal discipline. The government takes strong pro-active steps to reduce the deficit. This is, of course, extremely tough politically in the absence of a massive fiscal and financial crisis. But unless pursued promptly and aggressively, the government winds up forced to do it anyhow — albeit with more urgency and greater trauma for the country and its people.
I have speculated in “Obama’s Ides of March” that Bernanke will choose Path #1. To do otherwise would be to shut the government down. I do not believe they can borrow the amounts required at anywhere near reasonable interest rates. Path #2 drives interest rates up so high that any chance of an economic recovery is quashed.
Path #3 is the only solution. It will be the last one tried and done so when our situation is much worse.
I am usually not the guy to submit comments on other’s articles, but for this article I just had to do it. I’ve been cruising through your website a lot nowadays and I am really impressed, I think you could really become one of the main voices for this topic. Not sure what your free time is like in life, but if you started devoting more time to writing on this site, I would guess you would start receiving a mass of visitors soon. With affiliate stuff, it could become a great passive income source. Just a concept to ponder. Good luck!
“Human beings adapt and adjust, as do governments and central banks.” That’s an important point. It would explain, e.g., why gold experiences all kinds of temporary bubbles and pricks on its march upwards as currencies are devalued.
Hi Monty:
Perhaps you would be so kind as to explain what that money chart is. I can look up definitions of M1, M2, M3, etc., but I’m not sure that these are necessarily the same as the monetary base chart above. Since money can now be made in the virtual, computer world, when we talk about “printing” money, we actually mean creating money ex nihilo in most instances; as consumers, we don’t ever see this money, as the people in Weimar Germany or Zimbabwe today. But nevertheless, it’s been created and its sits somewhere on the balance sheets of banks, if I understand correctly. Eventually, with all this money creation, it will be necessary to print currency to keep up, not so much by printing wheel barrows of it, but by adding zeros to the denominations of bills.
This one thing I know: as an investor living in Canada, with a good credit rating, starting in the Fall of 2008, my effective ability to borrow (with combined HELOC and margin accounts) increased to close to $1-1.5 million–using only my modest house and my margin account. So even while credit was shrinking elsewhere, I have been able to greatly expand my buying power (I only use a fraction of it for my investments–it’s actually quite daunting to have that much credit facility).
Can you comment on this at all?
The money chart represents the monetary base. Another way to think of the monetary base is to think of it in terms of assets on the Fed’s balance sheet. In order for the Fed to acquire assets, they must pay either in cash or (today mostly) electronic entries to the seller’s account. Regardless of whom the buyer is, the money supply is thus increased. Monitoring the Fed’s assets is a way to determine whether the Fed is actually pulling back or expanding the money supply.
Thanks so much for this answer. Do you think that this money base is the real or the best measure of inflation? I believe that inflation is an increase in the money supply and that CPI is lagging indicator. But of course, we’ve had shrinking credit with subprime mortgage meltdown, etc. But I think that this expanded money base cannot but eventually lead to serious price increases in the future. Hence, I have a 150% stock portfolio mostly commodity stocks (Canadian oil & gas, gold mining).
I guess that’s why I’m picking your brain. I said in an earlier comment, as you know, that if economists could really predict the future, they’d all be fabulously wealthy. I ascribe to the Ferengi rules of acquisition — “inflation is good for business” (I made that one up);i.e., no matter what the conditions, the savvy investor can make money–George Soros for example is notorious for profiting from monetary problems in various countries.
I think that the monetary base eventually reflects in the upper tiers of money. At this point, the banks are holding historical records of excess reserves. That is why the velocity of money seems to distorted. Eventually that will change.
I think a strategy of natural resources and precious metals is good to defend against inflation. Non-dollar denominated (Canadian resources) seems to be a good strategy. But one never can be certain of how the future plays out. Unfortunately we are not dealing with an analogue slide rule where if you know one parameter you can predict the other with certainty. Human beings adapt and adjust, as do governments and central banks