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Two other views on long-term inflation [ClearOnMoney]
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Two other views on long-term inflation

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Commentary

Two other views on long-term inflation

25 Nov 2009 by Jim Fickett.

John Hempton of Bronte Capital is a former bank regulator and current fund manager in Australia, who often has quite cogent remarks on the markets. He argued in a post today (The Ides of March and the Fed exit strategy) that there is no cause to worry about inflation:

Over this crisis the Federal Reserve increased the money supply by literally trillions of dollars and several hundred percent. In an ordinary world this would have caused very rapid inflation – but suffice to say that this is still not an ordinary world. …

The Fed printed money to buy lots of riskier assets. Often these were assets owned by banks and the banks borrowed the cash from the Fed secured by these assets. About a trillion of the assets were qualifying mortgages guaranteed by Fannie and Freddie. Whatever, there is a huge increase in money supply (liabilities of the Federal Reserve) offset by an equally huge increase in assets held by the Federal Reserve.

The Fed has an exit strategy – a natural exit strategy. When people’s liquidity preference wanes they will want to hold risk-assets rather than cash. And the Fed owns trillions of dollars of risk assets. The exit strategy is simply to sell those risk assets and take back (and destroy) the cash that they created during the ciris [sic].

The right speed to do this is also – in some sense – naturally determined. The right speed is at the speed the general public wants to hold mortgages and other risk assets again.

Note that he argues against worrying about the current increase in the money supply. And there he may well be right. If the Fed exists all the current liquidity schemes in a timely manner, they may cause only temporary distortions. But John, and many others, make the mistake of defining the debate as one about current Fed manipulations of the money supply. In fact the real issue is about the long-term budget.

James Hamilton, an economist at UCSD who writes on the very useful Econbrowser blog, also posted today on inflation (Yes the future deficits are worrisome). He writes:

Paul Krugman … has been arguing vigorously that U.S. budget deficits are no cause for concern. I see things differently.

One of the arguments that Krugman makes is that, although the U.S. debt-to-GDP ratio is expected to double over a short period, the higher level would still be substantially below those currently observed in Italy and Japan, and only modestly above that of Belgium. Paul suggests that if these countries can run up debts of this magnitude without serious repercussions, so can the United States.

But European politics may not import all that well to this side of the Atlantic. Receipts of the U.S. federal government have never exceeded 21% of U.S. GDP, even at the height of World War II. A permanent move to taxation levels significantly above that would require a major shift in the political landscape, for which I see no consensus of support. To me that implies that any spending trajectory inconsistent with the long-established U.S. norm may be headed for a political brick wall. …

Is it possible that some time within the next five years, the U.S. Treasury will run an auction in which there are not enough bids to roll over the debt? My answer is yes.

His accompanying graph shows US federal receipts and expenditures since 1970, as a percent of GDP. Expenditures are far above any previous level, and still rising, and receipts are below any previous level, and still falling. The core issue, as Hamilton correctly explains, is that in order to resolve this situation, without inflation, much higher taxes would be likely be required, and that, in this country, would be political suicide for the party that pushed them through.