Posted on 06/08/2003 5:51:31 PM PDT by sourcery
Fearing Japan-style deflation Greenspan's Fed is buying Treasurys with dollars it mints for that purpose. Bondholders and other creditors should beware.
Sufferers in the great inflation of the 1970s may have doubted they would ever live to see the day, but the day is here. On May 6 the policy-making arm of the Federal Reserve declared that the rate of inflation is worrisomely, almost unacceptably, low. The Fed indicated it wouldn't stand for it.
You may now be rubbing your eyes. The Fed is purportedly in the business of making prices "stable." But now that prices are virtually stable, the Fed is worried they might sag. The Bank of Greenspan may not want a lot of inflation. However, it wants even less to have no inflation.
The speech patterns of the Fed are almost as oblique as those of its chairman, but here is the aforementioned declaration: "[T]he probability of an unwelcome substantial fall in inflation, although minor, exceeds that of a pickup in inflation from its already low level."
The New York papers are full of details of what a layman might describe as an unwelcome, substantial rise in inflation. Recent or impending jumps in rents, subway fares, bridge tolls, property taxes, income taxes and cigarette taxes have contributed to the growing apprehension that one day soon the only New York resident who will be able to afford to remain in the city is Michael R. Bloomberg, its billionaire mayor.
Unwelcome, these pocket-picking cost rises certainly are. Inflationary, they may not be. Inflation, as defined by the great Austrian School economist Ludwig von Mises (1881-1973), is an unwarranted rise in the money supply--more exactly, a rise in the supply of money not offset by a rise in the demand for money. Rising prices are a symptom of inflation, not the thing itself.
Thinking as the master thought helps to clarify the monetary situation. Persistent growth in money and credit over the past several decades was inflationary. Still, such growth was only deemed inflationary when, as in the 1970s, the prices of goods and services went up. When, as in the 1990s, the prices of financial assets went up (and up), that was a bull market.
There is no deflation in the U.S. today, but the chairman knows all about Japan, with its chronic recession, falling prices and little tiny interest rates. To keep at bay the threat of a shrinkage in money, prices and wages, the Fed is creating credit. It is purchasing government securities with dollars it mints for the purpose. Through these purchases the Fed is bidding up bond prices and pressing down interest rates. Hedge funds, mutual funds and pension funds are following in the central bank's bond-buying slipstream. One year ago the Fed owned $582 billion of Treasury securities; today it holds $647 billion, 11% more. Not much in this slow-moving, post-bubble economy is growing at double digits..
By the time it burnt itself out, the great bull stock market had singed the wings of many an equity moth. The bond bull market is becoming similarly irresistible. Proof is available in a sampler of the yields at which people are throwing their money, e.g., ten-year Treasurys at 3.7%, ten-year Wal-Mart Stores notes at just half a point over that meager rate and New York City 5s of Aug. 1, 2007 at 2.8%. (This is the same New York City that is raising taxes on its most mobile residents in order to plug a $3.8 billion budget deficit.)
There's nothing unprecedented about interest rates beginning with the numbers 1, 2 or 3. They were the rule rather than the exception in the days of the gold standard. But, as far as I know, no rates such as those quoted today ever appeared in a monetary system unballasted by gold or silver.
What ballasts the millennial U.S. monetary system is debt, and its weight is palpable. In the 1960s and 1970s total nonfinancial debt (corporate, government and individual) was around 140% of GDP. In the junk-bond revolution of the 1980s, the portion leapt to 180% and never looked back. Today it stands at 195%.
The Fed lives in mortal fear of a system so debt-clogged that not even a 1% bond yield could coax overextended debtors to consume or invest. The purpose of the Fed's May 6 pronouncement is to roll out the welcome mat for growth--and, by way of a higher inflation rate, to lighten the burden of debt.
But the dollar is the world's currency, and the non-U.S. portion of the world has a vote on dollar interest rates. Because the U.S. consumes much more than it produces and owes abroad much more than it owns abroad, torrents of dollars pour into the world's payment system. The holders of these dollars have Bloomberg terminals, too, and some fine day they might wake up and sell bonds. Who could blame them?
Attention, creditor moths: Beware of open flames.
James Grant is the editor of Grant's Interest Rate Observer. Visit his homepage at www.forbes.com/grant.
I'm definitely seeing growth in empty store fronts and for lease signs on all the newly built shopping centers and strip malls.
Richard W.
Well they sure as heck haven't let a little thing like high vacancy rates stop them. They're still building more. Maybe too much money in REIT's being "put to work" for investors. Once they fold, some insiders are going to pick up the pieces for cents on the dollar.
Richard W.
Lots of folks think the purpose of the FED is to tinker with the money supply so you can take the oscillations out of the economy. That would require perfect knowledge of the future and nobody has that, so in effect all you do by trying to control the business cycles is introduce more noise, not less. The most sound thing you can do is tie money to something real, like gold, and that's just what Greenspan has done, which is why inflation has been consistently low under his watch and why four presidents have decided to keep him.
Richard W.
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