Thoughts, essays, and writings on Liberty. Written by the heirs of Patrick Henry.

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April 27, 2011

The Inflation Won’t Come From The Fed

by Brad Warbiany

Everyone knows the Fed is pushing Quantitative Easing. By that, it means that when America is having trouble selling T-bills at advantageous interest rates, the Fed prints up some money to keep demand. It buys the bonds with newly-printed money. The recent run was $600B or so, and the Fed’s current balance sheet holds about $2.7T in assets (that they can choose to hold as long as they find prudent — since they print the money to keep them and/or roll them over).

But what if I told you that there was another $11T of outstanding US dollars* out there in the world, and that everyone except the US has a say in whether they are circulated. In fact, that those dollars are sitting on foreign soil is a very good thing for the US and has been for decades, but it’s not assured it will last forever. As I said WAAAY back in 2007:

As I’ve pointed out in the past, the dollar’s status as a reserve currency has largely allowed America to inflate with very little visible burden on our own citizens. We create worthless money, use it to buy durable goods from other countries, and watch as they hold that money or reinvest it in the sinkhole that are Treasury bonds. It’s a credit card on the world, and we can print whatever we need to pay it off…

…as long as they don’t wise up. If they do, suddenly that money might come back to us, and we’ll feel the results of the inflation we’ve engaged upon.

Inflation benefits those who see the money first — in this case, Americans who used that money to buy durable goods from overseas. It has the least benefit for those who see the money last. To date, that has been forex reserves, sovereign wealth funds, etc. But should those foreign nations decide they no longer want to hold US dollars, they’ll spend them right back into circulation — and they’ll eventually want us to sell them goods in exchange for those dollars.

If that happens, the inflation comes full circle and we feel it right here at home — without the Fed ever releasing the $2.7T they have on their balance sheet.

We’ve spent the last four decades, ever since Nixon “closed the gold window”, sending dollars abroad to other nations who stick them under their mattresses. This has been the persistent trade deficit we’ve held. Sure, some of those dollars came back to be lent to our own government to finance even MORE spending that didn’t come from the American people, but much of them quite literally got shoved under the mattress.

What happens if they want to spend those dollars? Well, dollar-denominated assets and goods produced in the US will rise in price. Oil, gold, silver, food (produced in the US), etc. Look at gold, for example: In the last year, gold has increased in dollar terms by over 32%, but by less than 8% in Swiss francs. USD vs other currencies show similar (but smaller) gaps. What can explain this? Well, if nothing else, that big buyers like China and India are using their dollar surplus, rather than their reserves in other currencies, to buy gold.

Where’s the endgame if this dollar-spending widens? Well, eventually those dollars are sold to people who don’t want to buy goods from China or US T-Bills: they want to buy US exports or US assets. That sounds good, of course; everyone likes exports! But is it good? Restate it this way: a durable good (i.e. product of American workers’ output) needs to be produced to leave our shores, and it increases the circulating money supply in the USA. The good we produce here is enjoyed elsewhere, while the increased money supply makes our own goods at home more expensive.

We change from trading our paper for other nations’ hard work to trading our hard work for our own paper back.

The endgame is the end of trade deficits, where we work harder as a nation to supply the rest of the world with goods in exchange for a lower standard of living here. That doesn’t sound good to me at all.

America has enjoyed a very privileged position in the world, and that position has only been possible from two things: other nations have trusted us and they’ve had no other options. The first is eroding to the point where they’re looking for the second. If we want to continue enjoying our position in the world, we need to convince the rest of the world that holding the US Dollar as a reserve currency benefits them — and neither trillion Dollar deficits as far as the eye can see or quantitative easing accomplish that.

When the inflation comes, it’s not going to be the Fed printing money — it’s going to be other nations sending us the money printed over four decades and expecting to buy something with it.

* Difficult stat to come up with. I used wikipedia to determine that there’s ~11T total forex reserves and about 61% of them are USD, which gives me about $6.7T in USD sitting in forex reserves. Add to that about $4.4T foreign holdings of US treasury securities, and I came up with a total number of about $11T.

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7 Comments

  1. “Everyone knows the Fed is pushing Quantitative Easing. By that, it means that when America is having trouble selling T-bills at advantageous interest rates, the Fed prints up some money to keep demand. It buys the bonds with newly-printed money. The recent run was $600B or so, and the Fed’s current balance sheet holds about $2.7T in assets (that they can choose to hold as long as they find prudent — since they print the money to keep them and/or roll them over).

    But what if I told you that there was another $11T of outstanding US dollars* out there in the world, and that everyone except the US has a say in whether they are circulated. In fact, that those dollars are sitting on foreign soil is a very good thing for the US and has been for decades, but it’s not assured it will last forever.”

    Both phenomena are dependent upon the other. You are trying to treat one as though it had nothing to do with the other. It’s simply not the case.

    Comment by procopius — April 27, 2011 @ 2:25 pm
  2. Why do you assume I treat one as though it has nothing to do with the other? They’re obviously interrelated, as the Fed printed that money in the first place and QE is one of the reasons other countries are leery of keeping the dollar as a reserve currency (along with the long-term debt outlook being the other primary reason).

    The key is that everyone’s focusing on the small-run impact of the Fed & Congress’ actions, but the waterfall of foreign divestment in dollars and dollar-denominated securities is far larger than the Fed’s immediate impact of interest rates or QE. They think they can manage it, but it can spiral out of their control in an instant if the world gets too spooked.

    Comment by Brad Warbiany — April 27, 2011 @ 3:57 pm
  3. I assumed nothing. Your first two paragraphs unequivocally denoted this. Now that you’re acknowledging of the association between one and the other you are at least being more intellectually honest. Or more educated on how US Treasuries work, either way.

    Comment by procopius — April 27, 2011 @ 5:18 pm
  4. Procopius: Your post did nothing to educate Brad Warbiany or anyone else about how US Treasuries work. You also didn’t force Brad Warbiany to acknowledge anything. All you did was detract from the main point and demonstrate to others that you are rude and arrogant.

    Comment by Dr. T — April 27, 2011 @ 6:07 pm
  5. procopius,

    Now that I reread your criticism, I think you’re a bit off base. These other nations don’t hold $11T in US debt — they hold about $4.4T of US debt and $6.7T of US currency.

    The debt may take time to unwind — it has to be sold off to someone or simply retire.

    But that $6.7T is money that has nothing to do with the Fed or the Treasury. It’s money those nations are holding as reserves — as cash. That money can be spent at any time the holders want.

    Comment by Brad Warbiany — April 28, 2011 @ 9:37 pm
  6. Okay Brad. So if I get the general gist of what you are saying, it matters not a bit that our central bank is directly purchasing its own nation T-Bills directly, with digitally printed money, at an ever increasing proportion over that last year. And this rate of self-printing-and-buying is increasing at this very moment.

    None of that has anything to do with foreign nations dramatically decreasing their purchases of US T-bills. China has already announced that they may cut their purchases by 2/3. Japan (suffering from the devastating earthquake) is actually using their own central bank to release money into the economy instead of the longstanding crucial US Treasury buying.

    So that $4T+ foreign debt reliance and steady decrease in participation… this has -nothing- to do with those foreign “using dollars to buy (US)goods” ?

    I would ask you, what do YOU think the basis of Quantitative Easing was? Do you simply think it was our central bank thinking we needed a good old fashioned Keynesian money-injection to make sure that we are over this “recession”?

    Sorry man but I think you may have causes and effects muddled. And I would ask you now if you consider yourself a Keynesian, Austrian, or other-than kind of Friedman offshoot.

    Comment by procopius — April 29, 2011 @ 4:15 pm
  7. Oh wait Brad… breaking news. It looks at though China is already embarking on its own anti-Quantitative Easing:

    “U.S. Treasury: China Has Decreased Its Holdings of U.S. Debt

    Friday, April 29, 2011
    By Terence P. Jeffrey

    (CNSNews.com) – Mainland China has decreased its holdings of U.S. Treasury securities since last October, according to a report updated today by the U.S. Treasury Department.

    Since September 2008, when they eclipsed Japan, entities in mainland China have been the largest foreign owners of U.S. government debt. But, as indicated by the Treasury Department chart linked here, Chinese ownership of U.S. Treasury securities peaked in October 2010 and has declined in each of the four most recent months reported by the Treasury Department.

    At the end of October 2010, China owned 1.1753 trillion in U.S. Treasury securities. That dropped to $1.1641 trillion by the end of November, $1.1601 trillion by the end of December, $1.1547 trillion by the end of January, and $1.1541 trillion and $1.1541 trillion by the end of February 2011.

    “So far in fiscal 2011—which began on Oct. 1, 2010—the U.S. Treasury has needed to redeem $4.176308 trillion in maturing Treasury securities and sell $4.769522 in new Treasury securities.

    At the end of February, according to the Treasury, the total U.S. debt was $14.194764 trillion of which $9.565541 trillion was publicly traded Treasury securities. Of those $9.565541 trillion in public Treasury securities, foreigners owned $4.4743 trillion—or almost 47 percent.

    The $1.1541 trillion in U.S. debt owned by the mainland Chinese as of the end of February equaled about 12 percent of the publicly held portion of the U.S. debt and almost 26 percent of the publicly held portion of the U.S. debt that was owned by foreign interests.”

    http://www.cnsnews.com/news/article/us-treasury-china-has-decreased-its-hold

    WHAT is that giant sucking sound, Brad, or you Dr. T ???? What is that?

    That my friends IS foreigners cashing in their chips, not playing another round in the Casino, and buying WHATEVER hard asset is even sensed in a 10,000 mile radius with those US Treasuries sold. THAT is YOUR “omg these overseas markets have so many US dollars at work because they are working so very hard and now, suddenly they are so prosperous that they want to buy our U.S. goods!!!!”

    Is that really what you peg all the CURRENT real life inflation upon???? You act like it’s still some futuristic event and you are such a jackass about your imagined economic prowess and your imagined Cassandra-like tragedy economic foresight that you totalfail anything close to resembling economics.

    Comment by procopius — April 29, 2011 @ 9:16 pm

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