When will inflation rear its head, How long does the USD have left? Christopher Laird April 16, 2009
In the last year and a half since Oct 07, the US Fed, ECB, BOE, BOJ, and others have either bailed out or done guarantees for over $20 trillion worth of toxic assets from paralyzed lenders worldwide. One might ask where is the inflation from that? Why isn't gold yet at $2000???
Well, it would be one thing if that $20 trillion were fed directly into the economy. That would have enabled big debt relief, and then world consumers would rebound almost immediately. The US mortgage market is about $9 trillion, and the US Fed alone has now committed over $13 trillion. They could have just paid off all mortgages no?
Pushing on a string
So where did all that money go? Well, it basically went to fill holes in financial institutions' balance sheets, while most of it never gets past there and into new loans to the economy. It's called pushing on a string. The Central banks can give money to financial institutions, but they can't force them to lend it back out. Besides the economy is in a shambles, and who wants to lend money out now? As long as this money sink is in place, the new money going out cannot fuel the economy or inflation. This is called a liquidity trap - ie the money the central banks lend out never gets past the insolvent lenders and lent out. And, as long as the losses keep growing, this will continue.
Black holes all over the world
These institutions have so many losses that each new bailout just goes into a black hole, and never meets the economy. IE money that was already lost is being replaced by the central banks, but just sits there till the balance sheet holes are filled. And there are a lot of awful big holes. So far, $20 plus trillion has yet to lead either to inflation, to new lending, or recovery in the economies. That money got sunk into a liquidity trap - stuck in zombie financial institutions - only it's worldwide. Since the new money never makes it to the economy, inflation does not appear yet. So, when will inflation appear? We think we have an answer to that.
Where the $20 trillion of bailouts went
Here is a diagram explaining how the $trillion of toxic assets/losses are basically being bailed out by world tax payers - and to little effect on the economies because the money never makes it to the actual economy. It just sits there in institutions to keep them from insolvency, and little else. And these losses keep increasing too, with little signs of abating. Wells Fargo may need tens of billions now, is the latest, and possibly needs over $100 billion by some estimates if things don't improve drastically. AIG is something like $150 billion of aid and counting. Next month, probably another $20 billion knowing what's been happening with AIG.
Comments: Toxic assets go from banks to taxpayers/central banks, who then sell new bonds to the bond market. The bailout money never makes it to the economy. 1. Central banks bailout banks, etc. 2. Banks send toxic assets/losses to central bank in return. Taxpayers have effectively become the holders of all the mammoth losses. 3. The bailout money never makes it from bailed out banks to the economy because they have such huge and growing holes in their balance sheets, so they sit on the bailout money. 4. The dashed line means the bond markets which, by buying sovereign treasury bonds from central banks/treasuries, are assuming the liability of the bailouts. The Chinese have already repeatedly stated they are tiring of this cycle.
Before all this, the bond markets would buy sovereign bonds to finance normal annual deficits, but now that market is asked to take everything. As central banks recycle new bond issues to bailouts, the bond markets are in effect being asked to be lender of last resort for the entire world economy.
The bond market will flag in this. It already shows signs of flagging. The US will need $3 trillion of new treasury issuance this year, to cover ongoing budget issues as well as the huge bailouts. I suspect there is not enough money in the bond markets to do this for long. If that is true, the US is running out of money.
When inflation will show up
So, to determine when inflation returns, we need to find out when this cycle in the above chart stops functioning. Basically, all the huge bailout efforts are doing is recapitalizing banks with growing holes in their balance sheets, which grow bigger, and central banks are not getting ahead of this.
Then the money sits there going nowhere. But the taxpayers are then saddled with all the losses. The sovereign bond markets will decide that all they are doing is enabling this process, (IE central banks are merely taking the losses and then selling new sovereign bonds) and transferring the new risk to the sovereign bond markets. The sovereign bond markets will not put up with this for long.
Already, many central banks are effectively monetizing their losses by buying equities directly, or buying their own treasury bonds - the BOE, Fed, BOJ, Bank Rossi (Russia). This type of action is verboten in the bond markets.
We view this new state of affairs- where the US is now running multi $trillion yearly deficits, as a new stage in the USD evolution, and a bad one. Before inflation rears its head, the Sovereign bond markets have to rebel on buying/underwriting all the central bank's bailouts.
We go into this in more detail in this week's edition of the PrudentSquirrel newsletter. IE how much time do we think the USD has till the bond markets rebel and stop buying US Treasuries, which will severely impact the value of the USD.
April 16, 2009
The Prudent Squirrel newsletter is our financial and gold commentary. Subscribers get 44 newsletters a year on Sundays, and also mid week email alerts as needed. We alerted our subscribers April 20, 08 that the USD was bottoming. The USD has strengthened significantly since. We also alerted subscribers that gold could rally big in late Nov 08. The alerts include quick notification of important financial news developments by email. Subscribers tell us that the alerts alone are worth subscribing for.
I had one potential subscriber ask me if the newsletter has much more content than these public articles, ie, if it was worth subscribing. The answer is that the public articles have less than 10% of our research and conclusions that subscribers see, not to mention the subscriber email alerts of important breaking financial news. We have anticipated many significant market moves in the last year, such as imminent drops in world stock markets within days of them happening, and big swings in the gold markets within days of them occurring. We have also made a number of good calls on big currency swings, such as with the USD, the Euro and the Yen. We invite you to stop by our site and have a look.
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Christopher Laird Editor-in-Chief www.PrudentSquirrel.com
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