Explosion in America’s Monetary Base

Make no mistake; the developed world is drowning in debt and there are only two viable options – a global economic depression or very high inflation. It is our contention that the policymakers have chosen the latter option and over the following years, we will experience the trauma of severe inflation.

Look. The American government is staring at total obligations of US$115 trillion, America’s debt-to-GDP ratio is off the charts and the American public is also up to its eyeballs in debt. Under this scenario, you can bet your bottom dollar that the American establishment will try to reduce this debt overhang through a process known as monetary inflation. If you have any doubt whatsoever, take a look at the chart below, which captures the incredible expansion in America’s monetary base.

As you can see, over the past two years, the monetary base in America has expanded from US$827 billion to an astonishing US$1.93 trillion! Until now, this surge in the monetary base has not produced a highly visible inflationary impact…yet.

But it is notable that America is not alone in pursuing inflationary policies. All over the world, the developed nations are printing money and debasing their currencies. In this era of globalization, no country wants a strong currency and everyone is engaged in competitive currency devaluations. This massive money and debt creation will cause an inflationary boom over the coming years.

In fact, those who erroneously believe that deflation is unavoidable should review Figure 2, which highlights the mind-boggling expansion in the balance sheets of various central banks. As you can see, America is not the only nation guilty of printing money; the Europeans have also jumped on this train to Inflationville.

Now, we are aware that many prominent commentators are still calling for deflation. “After all,” they argue, “how can inflation be a problem when bond yields are so low?” Well, these deflationists seem to be missing the point because the US Treasury market is no longer an entirely free market. We would argue that the Federal Reserve’s intervention is largely responsible for keeping bond yields artificially low. Over the past several months, the Federal Reserve has purchased most of the net new issuance of Treasury securities. The American central bank is engaged in this desperate act in order to keep interest-rates low. However, it is buying these Treasuries by creating money out of thin air. This is inflationary.

If our assessment is correct, somewhere down the road, the Federal Reserve will lose its battle and T-bond yields will soar. As more and more bond investors wake up to the looming inflationary menace, they will start demanding a higher rate of return on their capital. When that happens, the dyke will break and the Federal Reserve will become irrelevant.

America has run out of choices. If the Federal Reserve does not inflate away this mountain of debt, the biggest sovereign default in history is guaranteed. Now, given the ability of the Federal Reserve to create confetti money, we are convinced that it will opt for the inflationary solution. Inflation would certainly make America’s debt more manageable, but it would also dilute the purchasing power of the dollar. Of course, this inflationary agenda is not a secret and this is why many creditor nations with huge reserves are beginning to diversify away from the American currency.

In the past, when inflationary episodes spiraled out of control, hard assets were the prime beneficiaries and this trend is likely to remain intact in this inflationary episode. If our assessment is correct, over the coming years, stocks, precious metals, commodities and real estate will appreciate in value versus paper currencies. Furthermore, on a relative basis, we expect precious metals and commodities to outperform all other asset-classes. Conversely, we anticipate that cash and fixed-income instruments will probably turn out to be the worst assets to own over the next decade.

Bearing in mind the looming inflationary nightmare, we urge you to protect your purchasing power by allocating capital to precious metals and commodities-related businesses. Finally, we suggest that you consider allocating a portion of your capital to the fast-growing economies in Asia, like China, India and Vietnam. Such investments should prosper during the low-growth, high-inflation environment to come.

By Puru Saxena

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1 Comment on Explosion in America’s Monetary Base

  1. M2 monetary base dropped significantly from beginning of 09 until beginning of 2010. By Dec of 09, the m2 money supply is at a very low level. Seeing the date of this article is in fact Dec 30 of 2009, I'm skeptical of the accuracy of this information

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