Federal Reserve Inflationary Pressures

The inflationary pressures felt by the consumer have been created by the Federal Reserve.  Producer prices, as measured by the Producer Pricing Index (PPI), rose another 0.8% in January.  The most important take away from these numbers is that the core prices increased 0.5%, well above the 0.2% expected by the market.  Amazingly one headline I read stated; "Spike In Core PPI is Not a Sign of Future Inflation Pressures."  What is it then?  The article then went on to explain that all of the increase was due to a spike in pharmaceutical prices and that this will not lead to inflation.  For those of you on medication I am sure you will disagree!  Whatever you do do not get sick as it is going to cost you a bundle.

This report was followed up with price increases to the consumer in the Consumer Pricing Index (CPI).  These increased another 0.4% in January.  I am no mathematical genius but 0.4% multiplied by 12 gives me an annual rate of 4.8% and this is high and rising.  Core prices, those tracked by the Federal Reserve, increased to 0.2%, double what was expected.  This was also pushed aside as just a normal spike during an "expansionary" cycle.  Now don't get me wrong, these numbers are not out of control yet, but the problem is that they are being swept under the rug by the same people that are creating the inflation to begin with, the Federal Reserve.  Furthermore I would argue that with high unemployment and a poor housing market we have anything but a truly "expansionary" economy right now.

The Federal Reserve is currently buying an average of $110 billion a month in Treasury paper with money that is being created out of thin air.  They have therefore monetized most of the United States' deficit to June.  In fact they have purchased so much Treasury paper that they are now the largest holder of U.S. Treasury securities, surpassing the Chinese and the Japanese the two largest independent holders.  At this speed, by June they will own more than those two nations combined!  Foreigners are no longer funding our excesses, we are gorging on our own budget deficits and in doing so we are exporting inflation to ourselves and the rest of the world.

While this printing is going on and as long as the rest of the world does not lose complete confidence in the U.S. stock prices, food prices, energy prices and precious metal prices will continue to inflate.  At some point this party has to end and there are only two ways it can happen.  The happy ending is that the U.S. economy grows at a rapid clip on its own steam rather than being pushed along by the Federal Reserve.  The government becomes austere and the load of Treasury debt held by the Federal Reserve is slowly unwound without issuing new debt.  I put the probability of this happening at less than 10% in large part due to high unemployment, increasing costs of insurance, medical expenses and taxes and weakness in the housing market.  As I have explained in previous blogs, there is a bifurcation occurring in the market which will result in the second option occurring.

The second way out is that the world finally loses faith in the U.S. and its economic policies and the result is a rapidly falling dollar leading to rapid inflation followed by a collapse in all markets.  This outcome can be delayed (as the Federal Reserve is doing) but it cannot be avoided unless the policies of the government change to that of austerity rather than the current policy of increasing the level of debt.  Either way pain will be felt but with a $3.4 trillion budget announced by the Obama administration, austerity is not in their vocabulary and hence my disdain for the markets.  Enjoy the ride, but be prepared for the inevitable.