Tags: inflation

Fed Policy is Causing Inflation, Hurting Dollar

By Michael Carr   |   Wednesday, 27 May 2009 08:05 AM

Milton Friedman believed he knew what caused inflation. Simply put, the late economist stated: "Inflation is always and everywhere a monetary phenomenon."

This means that, when governments create too much money, inflation is sure to follow.

The Federal Reserve is responsible for creating money in the United States. In response to the credit crisis last year, the Fed added money to the economy at an unprecedented rate.

The amount of cash in the financial system had been growing at an average rate of less than 2 percent a year since 2005. Last fall, it jumped to an annualized rate of more than 16 percent. Although the crisis seemed to have eased, cash still is being pumped into the economy at a level very close to this rate.

All told, at least $9 trillion in cash is available.

Another source of growth in the money supply is the government's fiscal policy, which is the amount that Congress and the president decide to spend. In addition to normal operating expenses, they decided to respond to the crisis with a series of unprecedented bailouts.

It seems likely that no one knows how much money actually has been spent on the bailouts and stimulus packages. It certainly is more than $10 trillion, and it seems likely to keep growing.

Added together, there is about $20 trillion in cash and promised cash in the U.S. economy. The total production of the country, as measured by GDP, is about $14 trillion. This is the very problem Friedman warned governments to avoid.

More money is available in the economy than there is stuff to spend it on. The result is that those with money will be willing to pay more for the goods and services they want to buy. This is what economists call inflation.

Moving from economic theory to a rea-world example, the first place where inflation is likely to increase is in the hourly billing rates of bankruptcy attorneys. There are a finite number of qualified attorneys sufficient to handle the usual workload each year.

The government now is creating more demand for these lawyers by providing the money to complete several large bankruptcies simultaneously. Although there are very good reasons that Chrysler and General Motors should consider bankruptcy, those reasons existed for years and could have been dealt with earlier, at a pace the economy could handle without creating unintended problems.

By creating demand and providing money, the government is creating inflation in this very small sector of the economy. This idea soon will spread to other goods and services, and inflation is a certainty, unless money supply is decreased, according to Friedman.

Foreign investors already have begun reacting. The U.S. dollar enjoyed rapid gains as the crisis started and investors viewed the dollar as a safe haven. In recent weeks, the dollar has gone into a near free-fall and now looks to be resuming the downward trend that began in 2001.

Interest rates on the 30-year Treasury, the most sensitive to inflation, are up almost 50 percent since inauguration day. The price of crude oil is up almost 30 percent over that time.

Now is the time for long-term investors to stop worrying about the stock market. Stocks will continue to go up and down over the short term. Soon, inflation will be the primary factor driving investment returns, and prudent investors should be preparing for this now.

Inflation hedges include gold and silver, along with other commodities such as oil and corn. Equities that benefit from inflation also should be considered — stocks such as Plum Creek Timber and Cross Timbers Royalty Trust should benefit from rising land and wood prices.

Investors historically have bought stocks to protect their future buying power. With inflation looming, this is the perfect time to focus on selecting high-quality, inflation-proof stocks.

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MichaelCarr
Milton Friedman believed he knew what caused inflation. Simply put, the late economist stated: "Inflation is always and everywhere a monetary phenomenon." This means that, when governments create too much money, inflation is sure to follow.The Federal Reserve is responsible...
inflation
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2009-05-27
 

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