“But as bad as the fiscal picture is, panic-driven monetary policies portend to have even more dire consequences. We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s.
About eight months ago, starting in early September 2008, the Bernanke Fed did an abrupt about-face and radically increased the monetary base — which is comprised of currency in circulation, member bank reserves held at the Fed, and vault cash — by a little less than $1 trillion. The Fed controls the monetary base 100% and does so by purchasing and selling assets in the open market. By such a radical move, the Fed signaled a 180-degree shift in its focus from an anti-inflation position to an anti-deflation position.
The percentage increase in the monetary base is the largest increase in the past 50 years by a factor of 10 (see chart nearby). It is so far outside the realm of our prior experiential base that historical comparisons are rendered difficult if not meaningless. The currency-in-circulation component of the monetary base — which prior to the expansion had comprised 95% of the monetary base — has risen by a little less than 10%, while bank reserves have increased almost 20-fold. Now the currency-in-circulation component of the monetary base is a smidgen less than 50% of the monetary base. Yikes!”
It will be a medium miracle if we get through this without a bad bout of inflation. What type of inflation? Garden variety inflation or hyperinflation a la Weimar Germany? My bet currently is 10 to 12% inflation in a year combined with a stagnant economy. Stagflation, a truly ugly part of the Seventies, right down there with disco and leisure suits, is going to make a return I suspect. However, right now the inept powers-that-be in Washington are redlining the economy, so I really wouldn’t be that surprised to see hyperinflation take off if we get unlucky and if the Obama administration learns nothing from the current fiasco this year. Keep those wheelbarrows handy for future shopping expeditions, just in case.
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