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Battle Between Inflation and Deflation Must Be Monitored
The global economy has inflationary and deflationary forces butting heads. The pressures on the side of inflation include low interest rates and massive amounts of liquidity in the banking system. The forces related to deflation are high levels of debt and banks that are hesitant to lend. How this battle plays out is important to investors. Attractive investments in an inflationary environment are almost polar opposites of those in a deflationary environment. Both camps have strong arguments but, for numerous reasons, the Fed would much prefer inflation over deflation. The deflation scenario needs to be respected, but the Fed will not remain on the sidelines if asset prices continue to fall. Our job, as money managers, is to monitor the situation with an open mind, having plans in place for both inflation and deflation.
The chart below was created on the website of the Federal Reserve Bank of St. Louis. It shows the eye-popping expansion of the money supply as financial institutions swapped securities and other "assets" for cash via borrowing from the Federal Reserve. Borrowing prior to 2007-2008 crisis is barely visible on the graph. Recent borrowing is an extreme example of the term "spike" on a graph.
Fed's Options in a Zero Rate Environment
At a time when interest rates are near historic lows around the globe, it is important to understand possible nontraditional ways for policymakers to fight deflation. These 2002 comments made by then Fed Governor Ben Bernanke outline in detail Federal Reserve options in a low interest rate environment. It may help us better understand the possible range of Fed actions in the next 24 months.
Links to Articles & Research On The Expansion of the Money Supply
- Open-Ended Means Unlimited QE Reuters August 2012
- More Money Printing On The Way? Bloomberg July 2012
- Deflation Coming To China? CNBC May 2012
- IMF Cites Deflation Threat Fox Business April 2012
- Deflation Is Europe's Real Problem CNBC November 2011
- Talk of Deflation In Europe San Francisco Chronicle September 2011
- QE3 On Way? CNN June 2011
- Will Inflation Derail The Bull? Ciovacco Capital Management March 2011
- Fed Avoids Dirty Word "Core" The Wall Street Journal March 2011
- Banks Plan To Lend In 2011 The Wall Street Journal December 2010
- Inflation in 2011? Business Insider December 2010
- More QE On Way From Fed The New York Times October 2010
- 3 Reasons to Keep Printing Money The Atlantic June 2010
- Veering Toward Hyperinflation Business Insider June 2010
- Double-dippers Reject Reality Toledo Free Press June 2010
- Contrarian Analysis Supports Bull MarketWatch October 2009
- PIMCO Says Dollar Slide To Continue Bloomberg October 2009
- Money Growth Still Needed Forbes October 2009
- Bulls Have Room To Run Bloomberg October 2009
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