Tuesday, October 20, 2009

Inflation is Not The Bogeyman

This from Wells Fargo's research dept. (you need an account to access this material):

Interest by foreign central banks to increase their gold holdings begs a more fundamental question. Have they lost confidence in the dollar? Probably not, at least not yet. As noted above, foreign central banks have purchased $53 billion worth of Treasury securities over the past 12 months. Although the pace of purchases has slowed from its rate of a year or so ago, we think foreign central banks would have become outright net sellers of Treasury securities if they had "lost confidence" in the greenback. Foreign central banks are not dumping dollars, but they appear to be diversifying away from the greenback on a flow basis.

As we argue in a recent report, however, indications that the United States is not serious about addressing its long-run fiscal challenges could eventually lead foreign investors and central banks to reassess their willingness to continue financing U.S. government obligations. Although there is little evidence to date to suggest that that point has been reached, the price of gold could skyrocket if foreign governments do indeed lose confidence in the dollar.

Inflation is inevitable when the economy runs in cycles. The hyper-inflation of the '70s is not a big worry, however, even with gold prices currently shooting up very high. What the report states is that gold prices are surging partly because foreign central banks are diversifying their portfolios rather than relying so heavily on the dollar. We've heard a lot of talk about foreign governments' turning to other currencies or gold for their investments, which would send the dollar into the toilet and inflation into the stratosphere. But if that were true, then why are all these foreign central banks still net buyers of US Treasury securities (i.e., they buy more US debt than we buy their debt). If they had lost confidence in the dollar, then they'd be net sellers of Treasuries.

What this means for you and me is that we'll be able to finance homes and cars at very low rates, and have to find other ways besides CDs and money market accounts to earn a decent return on our money, for some time to come. Now, as the piece warns above, if the US doesn't take a serious approach to its long-term problems with fiscal responsibility soon, foreign investors may indeed lose confidence in the dollar.

Bruce Bartlett believes new taxes are in order to raise revenue. Remember him? He's one of the pioneers of supply-side economics and a hardcore Reagan conservative. Read part of his interview with Money Magazine here. Money quote:
As Larry Summers [Obama's chief economic adviser] once put it, we don't have a VAT because liberals think it's regressive and conservatives think it's a money machine. We'll get a VAT when liberals figure out it's a money machine and conservatives figure out it's regressive.

True, that. And nearly impossible to achieve.

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