Wednesday, May 27, 2009

The inflation threat

I mentioned in early January that inflation was a real danger as we pull out of the recession. It is good to see others have noticed. John Taylor writes in the Financial Times"
The fact that the Federal Reserve is now buying longer-term Treasuries in an effort to keep Treasury yields low adds credibility to this scary story, because it suggests that the debt will be monetised. That the Fed may have a difficult task reducing its own ballooning balance sheet to prevent inflation increases the risks considerably. And 100 per cent inflation would, of course, mean a 100 per cent depreciation of the dollar. Americans would have to pay $2.80 for a euro; the Japanese could buy a dollar for Y50; and gold would be $2,000 per ounce. This is not a forecast, because policy can change; rather it is an indication of how much systemic risk the government is now creating.
Megan McArdle comments on this and another article:
Short term yields firmed up this week on better consumer confidence data, but short-term yields shouldn't be what we worry about. Eventually the treasury has to roll that debt or pay it off, and if interest rates spike, that can prove catastrophic--just ask Argentina. The five year, seven year, and especially the thirty year auctions will tell us much more.

Update: From Jack Healy in the New York Times (5-22-09)
The dollar skidded to its lowest point in five months this week, battered by creeping fears that Washington’s costly efforts to stimulate the economy are growing harder to finance and may set off an unwelcome bout of inflation.
But while lower demand and a sluggish economy normally act to constrain inflation, some experts said the pressure on prices in the months ahead might be driven by economic activity elsewhere in the world, not just inside its biggest economy.

“There is growth in the emerging markets,” said Mr. Darst of Morgan Stanley. “There’s an international demand as well as a U.S. demand. The inflationary pressures are going to be coming from outside the walls of Troy.”

See also here.

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