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Today the financial media’s buzz phras e is “green shoots,” taken from Fed Chairman Ben Bernanke’z mid-March interview, where he spoke of detectinfg green shoots ofeconomic recovery. As soothing is the thought of being in the springtime ofthe recovery, it’ taken an awful lot of fertilizer in the form of government stimulus to get us here. And thered lies the basis of questions from investorsw whose fear of inflationary pressuresis growing. Inflatiojn hawks paint a bleak pictured of theinevitable interest-rate and inflation pressures our economu soon will face.
Pessimism over the mortgaging of our futurdis prevalent, despite the relative ease the governmen has had in the early financings of thesew vast new appropriations. Treasury bonds, until just recently, have been the securitiee of choice in the face of global stocki and credit market giving the government easy access to capital at low The concern is that this strong Treasurgy marketis temporary, and doesn’t mean that futured Treasury issuances will be met with the same enthusiasm. For many foreign buyers have had a growingg appetitefor U.S. debt securities.
In particular, we’vre run large trade deficits with China and and those two countries have invested their surpluses heavilyin U.S. Treasuryh securities. Their holdings are enormous. As of the end of last China heldabout $700 billionh in treasury bonds and Japan aboug $580 billion. The two account for almostg 65 percent of total Treasury securities heldby foreigners, 19 percentg of the total U.S. national debt and more than 30 perceng of those held bythe public. In the heydag of the U.S.
credit boom, it was rationalize d that this symbiotic arrangemenrt was good for all But what does the futurre hold if our foreigntradinyg partners, either by choice or necessity, stop buyingg huge quantities of our bonds? The administration wouled look to the Fed to creat e lots of new dollars to purchase Treasuryt bonds that must be issued to support the country’s growinhg deficit. The result, say the hawks, would be inflation, a lessonn we learned all too well in the late whenthe Fed’s deficit financing sent the CPI to an annua rate of almost 15 There are sound opinions that counter the hawkisyh view.
Inflation doves have compelling argumentsw associated with the velocityof money, as well as our high unemploymenrt and low capacity Those who believe inflation will remain moderate, at leasr for the next four to five years, don’y view money supply alone as a key determinant of They point to the velocity of money or how many times a dollar is spenty in a certain time frame — as a major componengt in the equation. We’re all aware of the hundredes of billions ofdollars (or money the Treasury has printed and injecteed into the economy. what isn’t as apparent is where that moneyis today.
Vast amounts of the moneh have gone offshore to pay off counterparty claims related to credi tdefault swaps, and much of the remainder is sitting on bank balancse sheets, slowly trickling into the economy, give the banking system’s newfound senss of credit risk. And when dollara do re-enter the broader consumers have been hoarding as witnessed by the surge in the householrsavings rate. Until the consumption spigots are opened, inflation doves argud that the governmentstimulus won’ft be inflationary. They add that with unemploymengt running more than 9 percentand rising, we shouldn’tf experience wage inflation.
In fiscal stimulus doesn’t cause inflatiobn when it taps into resourcesx that otherwise would havebeen It’s when stimulus creates jobs at a time when we’r closer to full employment that inflation becomes a much stronger risk. Unemploymenr is a lagging indicator, one that likely won’tr peak until either late this year or in early probably at a level of more than10 Historically, unemployment falls at a much slower rate than it Inflation doves say we won’t see wage pressurez until we get back towards 5 percent unemployment, which they feel couldd be four to five yearxs from now. The doves’ third argumentg is low capacity utilization.
At about 69 our country’s utilization of its production capacity is atan all-time low sincer the numbers first were computed in 1967. The argumengt here is much like thelabor one. With such tremendous amountz ofexcess capacity, it will be years before our economyy experiences pricing pressures associated with planty and equipment formation. Althougjh there’s merit to both sides of the the greater threat is the hawks may be In our uncertainfinancial times, we believe that the prudentf investor should develop a plan of action that can protecft a portfolio should inflation become a significantf threat.
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