By: Larry MacDonald
The U.S. monetary base has doubled to $1.7 trillion (US) since September, a consequence of the Federal Reserve flooding financial markets with liquidity to head off a collapse of the financial system. This startling jump has many observers worried about inflation taking off. Some even think the magnitude of the financial crisis will require an expansion in the money supply that could lead to hyperinflation.
This reminds me of the time I was following the macroeconomic commentary of a bank economist during the 1990s. As the economy recovered from the recession earlier in the decade, he kept warning about inflation reappearing. His warnings went on for a couple years – yet inflation remained well behaved. Then came news his reports were no longer available. He had been let go by the bank.
I wonder if the inflationists this time around will similarly discover that their fears were misplaced. In March, the U.S. consumer price index (CPI) fell 0.4% year-over-year, the first decline in half a century. The core CPI was up 1.8% — mostly due to an increase in cigarette prices.
But what really makes one question the inflationary thesis is the amount of slack in the economy. As the Financial Times of London reports, the Congressional Budget Office calculates the “output gap” will be 7% in 2009 and 2010. They don’t expect it to be closed before 2015. Prices don’t normally start going up until the “output gap” is a lot smaller.
Many people, including several well-known investors, have been calling for a bursting of the bubble in U.S. government bonds. I have been looking at going short with the ProShares Ultra-Short 7-10 Year Treasury (PST) or ProShares Ultra-Short 20+ year Treasury (TBT) exchange-traded funds. However, until there is a resurgence of inflationary pressures, the decline could be less dramatic that what might initially be expected.
4 Responses to “ Inflation fears misplaced? ”
Actually, the 30 year long term treasury has already gone up from around 2.5% to 3.8% currently (up over 50%). I went long HTD instead of TBT a couple of months ago (did not want to hold US dollars as I had expected the Cdn $ to strengthen).
Problem with the leveraged ETF is that returns are less than 200% return of underlying index over longer term due to daily ups and downs. So even though my bet was right, I’m not making the return I had expected. Not sure if there’s a better way to short long term treasury.
By John Gan on Apr 23, 2009
John
HTD was a good choice to avoid the currency risk. PLus, I don’t think the Fed is buying that maturity and holding down the price like it is on the 10-year Treasury.
There will be some downward pressures on Treasury bonds due to the government’s deficit going to 12.5% of GDP. I had originally thought there might also be upward pressues due to inflation resurfacing, but lately have begun to question that assumption (in the near to medium term, anyway).
I couldn’t find any unleveraged inverse bonds funds and would have preferred them to the leverged ETFs to avoid the “constant leverage trap” There are some US mutual funds that short gov bonds without leverage but they can only be bought by US citizens, I believe.
By Larry MacDonald on Apr 23, 2009
In the land of those who buy groceries, food inflation is evident. I was out of the country for 6 weeks and when I returned, I really noticed that grocery prices had gone up, and not just for seasonal produce. A few days later, a Statistics Canada report was released that said food prices rose by an annual rate of 7.9% in March, the biggest increase since November 1986. Core inflation was also up. I think investors should be watching the inflation rate closely.
Gail Bebee
http://www.nohypeinvesting.com
By Gail Bebee on Apr 28, 2009
Gail
Going by the official measures of inflation, i.e. consumer price indexes, prices are now falling. The CPI is an average so some items will be showing increases and other negative.
By Larry MacDonald on Apr 29, 2009