Will the Fed Push Inflation to Help the Spenders?
While driving to work yesterday, I heard an interesting interview on the Fox Business Network. The discussion was focused on what the Fed would be doing in the coming months to address the multitude of economic problems that relate to monetary policies over which the Federal Reserve has some control.
Everyone in the discussion agreed that the Fed was between a rock and hard place in trying to concurrently deal with rising deficits, continued contraction of economic activity, and inflationary pressures.
The logic is this. As inflation increases, the real cost of borrowing is lowered, because borrowers are repaying the debt with inflated dollars. If the borrower has a 7.5% fixed rate mortgage but inflation is running at 5-6% annually, the real cost to the borrower of repaying that loan drops dramatically. (This assumes that the borrower’s income keeps pace with inflation.) Voila’ – the housing market is cranked up because those mortgage interest rates don’t look so bad after all.
The Fed may have no choice but to accept higher inflation rates for a period of time. It is going to be increasingly difficult to get foreign countries to finance our budget deficits by selling them Treasury bonds. Foreign buyers are concerned about devaluation of the dollar as well as relatively low interest rates on the bonds. Instead, the Fed will be forced to monetize the debt by purchasing Treasury bonds directly. (This has already started with various “supplemental financing programs” announced by the Fed in September of this year.) If you are wondering what “monetizing the debt” really means – it’s very simple. The Fed tells the Mint to print more money, the money is given to the Fed (which is the institution that distributes it), the Fed gives it to the Treasury to spend in exchange for the bonds, and the government promptly spends it. This is the ultimate inflation generator because the money basically goes directly from the printing presses into circulation, dramatically increasing the supply of dollars. Ouch.
All of this helps spenders who have lots of consumer debt and penalizes those who have little or no debt and have saved their money. The government has a history of shafting savers with fiscal policies that favor spenders. If the Fed drives inflation up as predicted, it will be more of the same. So if you start hearing or reading about the Fed “monetizing government debt” to aid the housing market, think “printing money” and be prepared for inflation to rise.
What do you think the Fed will do?