Singapore-based financial blog that aims to educate people on personal finance, investments, retirement and their Central Provident Fund (CPF) matters.

Sunday, 14 December 2014

High Inflation Coming to US

High inflation rates will be coming to US because of the huge amount of printing by the Fed and a dysfunctioning fiscal policy. It will not be tomorrow, next year, or 5 years, but it will definitely come when the Fed is no longer able to support the economy.

PS: This will be a economics lesson, and the market outlook will be at the bottom.

The current monetary and fiscal policy in the US (and most other countries) are dysfunctional and highly skewed towards creating inflation.

Fed's duty is to control the money supply and interest rate in the economy. However, the Fed only has the mechanism to pump money into the economy (permanent supply) but am only able to remove money out of the economy by increasing interest rates and issuing bonds (removes money supply temporary).
All bonds have a maturity date. The money will have to flow back into the economy with interest once it is matured. Some may argue that the Fed can keep rolling over its bonds to lower money supply, but it is only snowballing the monetary catastrophe to the future with either higher interest payments (hence higher money supply that inevitably will reach the market) or ever-expanding money supply.
The Fed has no way of removing money from the economy permanently.

Fiscal (Govt)
Fiscal policy on the other hand is unable to pump money into the economy, however, it does have the ability to suck the money supply out of the economy permanently through taxes. Technically, only taxes are able to remove money supply from the economy.
While the Govt are unable to pump money into the economy, they can help ensure that there is more supply flowing in the market by not sucking them out (eg; lower taxes).

Marriage of the 2 is a Disaster
Fed is currently nearly addicted to QE (printing money) and low interest rates because the market demands for it and the Fed does not want big swings in the market - because big swings in market usually results in big swings in the economy, which for a still recovering US economy is not good.
No one likes high interest, every one likes a low interest, it makes the housing loans, student loans, any other loans cheaper. So the Fed in its attempt to please the market and the economy, will have to continue keeping interest rates low.

Govt (Democrats or Republicans) do have the ability to control money supply in the market, but they will not use it until it is the last resort - they might not even use it as a last resort. No one likes high taxes, be it personal, consumption or corporate, no one likes them. Any party that suggest a higher tax rate would most likely face losing the next election. And because getting re-elected is the most important thing for a politician, they will not risk raising taxes even if it is the right thing to do.

With the 2 working hand-in-hand, we have a financial  system that is prone and made for an unrestricted expansion of monetary base without the desire to reduce it. Any politicians attempting to reduce the supply will be faced with unpleasant retaliation from the economy. Fed chief would face a possible market downturn while a politic party risk losing the election.

With an inflationary situation almost unavoidable in US, it is best to position yourself with investment products that are inflation-hedge like stock indexes and commodities (real commodities like gold bar! Yes! start buying gold bars).
On the other hand, you can also start diversifying your portfolio to include securities and assets from other countries to hedge against a possible free-fall of the US dollar.

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