Sugar High

Mitt Romney recently spoke to the Federal Reserve Chairman, Ben Bernanke, to ask him not to initiate the Fed's latest round of quantitative easing (QE3).  This request fell on deaf ears ... for the Fed is now pumping $40 billion a month into the U.S. housing market by printing money to buy mortgages ,,, and, unlike previous quantitative easings, there is no indication of when it will stop its monitary printing presses.  This, of course has inflated the stock market and deflated the dollar.

America is experiencing another financial "sugar high" ... with no Michael Bloomberg or Michelle Obama to nanny-state us down.  The Fed has now expanded its normal mandate to effect "full-employment" ... the diametric opposite of its primary mandate of "controlling inflation." (This is because our current administration has no clue on how our economy can otherwise reduce unemployment rates.)  Everyone who has a brain knows that this fire-hose monetary expansion (QE3) combined with the Fed's previous QE1 and QE2, will be inflationary ... eventually  The question is, "When?" 

Perhaps I can propose an answer to this query?  Bernanke and Co. have calmed some investor worries by claiming that they have "a plan" to [eventually] deleverage the Fed's balance sheet.  I will here and now guess what this plan might be -- at some point the Fed will open the flood gates and allow inflation to come charging back.  If the Fed has been, by then, able to substantially extend the maturities of the debt it now holds (which it has been doing with a vengeance under "Operation Twist"), then the price of this government debt will plummet and the Fed can either write it down on its balance sheet or buy it back with dimes on the dollar.  Of course, the fact that other investors of this debt (pension funds and many IRA retirement funds of our seniors ... among others) will be financially hosed seems not to be a concern of the Fed ... as it has bigger fish to fry (getting Obama re-elected).

The reasons that the United States is not experiencing run-away inflation at the moment are three-fold:
- First, the Fed is keeping interest rates artificially low (short term rates are essentially zero) with its open-market operations,
- Secondly, because of our rotten economy and high unemployment, there is virtually no wage inflation (Chicago teachers being a visible exception),
- And lastly, because one of the major drivers of inflation is housing costs (home selling prices are converted to equivalent rental rates), this area has been profoundly deflationary ... offsetting raging inflation in medical and education costs. (One can also argue that food and fuel prices have been obviously inflationary, but, since they are excluded from core inflation calculations, they don't have the impact that they otherwise might.)

Now, let me extend this Fed analysis ... the fact that QE3 is specifically directed toward the housing market through packaged mortgages purchasing leads me to suspect that the Fed's plan to deleverage its balance sheet may, in fact, already be underway.  What the Fed is doing is bound to reduce the cost of mortgages ... therefore increasing the cost of homes.  And, if that one deflationary drag (housing) is eliminated with QE3, might not that usher in real robust inflation?  So instead of suffering from diabetes from all this sugar, the U.S. economy will return to a hypoglycemic state (read out-of-control inflation).

Q.E.D.