The Inflation Won’t Come From The Fed
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.