Thursday, January 13, 2011

Will Exporting Inflation Boomerang?

According to Martin Hutchinson of Money Morning, one of the reasons why U.S. inflation has been relatively tepid despite healthy increases in the money supply is because the U.S. has been exporting inflation.
U.S. monetary policy has involved excessive money creation since 1995, fueling asset bubble after asset bubble. However, it has not produced inflation in the United States because the dollar is a reserve currency, so excess dollars flow to countries whose economies are more vulnerable to inflationary pressures.

In the 1990s, the excess dollars flowed to Argentina, whose currency was pegged to the dollar. The imported inflation wrecked Argentina's sound policies of that decade and contributed to a debt-fueled collapse in 2001. Since 2008, the excess money has gone to China, India, Brazil and other fast-growing emerging markets. It also has fueled a massive growth in foreign exchange reserves among the world's central banks. Central bank holdings of forex reserve have grown more than 16% per annum since 1998.

China, India, and Brazil all currently have massive inflation problems....
Those problems are likely to rebound to the U.S., as indicated by much stronger commodity prices. Adding to the trouble is the unlikelihood of the Fed raising rates until 2012.

It's now an open secret as to why: mortgage resets. In order to prevent a second collapse in the residential housing market, which is already clogged with excess inventory, mortgage rates have to be as low as possible. This graph shows another peak in resets, largely from option ARMs, coming this year:

If mortgage rates are as low as they are for the rest of the year, and for a time in 2012, then the reset demon will finally be laid to rest. There'll be a cost, no doubt about it; gold and silver are already set to become the new asset bubbles. I have to say that the U.S. is lucky that the deflationist view has taken hold in Wall Street and other money centres around the world. Had the bond vigilantes not been supine for the last couple of years, the U.S. economy would be in a terribly tough spot. Thanks to U.S. Treasuries being a bubble asset as of now, and thanks to government-guaranteed mortages falling into line, the U.S. might well escape the aftereffects of the last bubble with only a new asset bubble to show for it.

As of now, anyway.

Inflation itself might well be the next bubble in the U.S.

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