Can the Fed Tighten the Money Supply in Time?

Lately I’ve been reading opinions about the market that tell their readers not to be too worried about inflation. Sure, they’ll admit that expanding the money supply correlates sharply with inflation, but they tell me that Ben Bernanke will take all that liquidity out of the system when the time is right. I have no idea where they get this idea; Alan Greenspan certainly wasn’t able to contract the money supply after he inflated it to ward off recession. Do we really believe that Ben Bernanke is going to do any better?

One opinion I read indicated that mopping up inflated money supply. After all, all the Fed had done was monetized the government’s debt. Since that debt is held in the form of US Treasury bonds, it should be easy to contract the money supply again by simply selling the bonds. The author of this opinion was rather misinformed, because they did not seem to understand that when the Fed monetizes bonds, it does so with money that it yanks out of thin air. The money then enters the system by way of the bank.

Now, the Fed selling that bond does not actually extinguish the new money. Because someone else is paying money  for the bond with goes into the Fed. The Fed still carries this money on its books. So the tools that Ben Bernanke has to prevent inflation are the same tools that Alan Greenspan had, and they didn’t work too well for him. The simple truth is that has been proven time and again is that if you want to prevent inflation you should not expand the money supply. You can rationalize that you’ll have lots of tricks up your sleeve to prevent inflation down road, but those banking tricks end up being ephemeral when they go to be used. Like the promises an addict makes himself on the way to indulge his addiction, people can come up with all kinds of reasoning that explain that inflation won’t be a problem later if they can get one more inflationary fix today. 

It’s was this kind of thinking that got us into this mess to begin with. If we just indulge more of the same, how can we expect a different result? Are we really to believe that the same people at the heads of the same institutions that got us here to begin with are going to see the error of their inflationary ways and not mess it up this time? Or are we really just doing what most addicts do best- lying to themselves?

I’ve long written in this blog that gold is going to go higher because the economy is going to go one of two ways. If it continues to collapse, people will demand gold because it is a tangible form of wealth that is not someone else’s liability.  If the central bankers and politicians are able to do as they wish and inflate our way out of this problem, then people will demand gold as a hedge against inflation. Either way, gold comes out a winner.

The reason I think gold has been just treading water the last few weeks is because we seem to be in this awkward in the middle time where people hope that the economy is going to recover and, simultaneously, that inflation is not going to be an issue. We do not have a rational basis for this belief, but it seems that people’s belief in a return to the “goldilocks” days of the economy has paralyzed people from making any dramatic moves. At least, that’s how it appears. 

If you peer closed, you’ll notice some serious cracks in that damn of beliefs that’s holding back the flood of bad news. For one, long term bonds have continued to decline in value (sorry Lacy Hunt).  Secondly, gold, which was knocked down in price as the IMF once again considered a motion to sell some of it’s gold at auction, has risen back above $900 an ounce. Demand for gold now includes Posted on Categories Investing and Financial DoomsdayTags , , , ,

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