Monday, November 3, 2014

Inflation on the horizon?

In general, inflation occurs when there are too many dollars chasing too few goods. Moreover, inflation is the result of a decline in the value of the dollar. Therefore, it takes more of them to buy the same goods and services. Given the massive increase in supply of the of ‘Dollars’ , why isn’t inflation higher than 2.0%? There is a good reason for this. 

To begin, let’s discuss how the Fed increases and decreases the money supply. When the Fed purchases bonds through its Federal Open Market Committee (FOMC), it removes cash from its balance sheet and holds the bonds in its place. This increases the reserves which are available for banks to lend and invest and the economy tends to grow. However, over the past six years, much of this “expansion” has remained in reserves rather than entering the actual economy. Why? The economy never provided us with a strong enough read to allow businesses to expand and for banks to lend to new ventures. Too risky. Especially when they could borrow at 0% and reinvest risk free at 7X leverage in US Treasury securities. The money is there, but the will power is not.

Now with the dollar sky-rocketing versus the Yen (see chart attached), which was coming, and strong versus other currencies, inflation is even less of a concern. 

One more item of interest. More than one-third of the US debt is owned by foreign countries, with China and Japan neck-to-neck on the top. Social Security owns 16% followed by other federal government entities (13%), and the Fed (12%). 

Little to no inflation, US is strongest of largest global economies, the ECB is printing, the BOJ is printing. Where is money going to flow? Where is the incentive for higher rates?
I do not see it!

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