James Grant (of Grant’s Interest Rate Observer) had a great interview on CNBC Wednesday. I’d say this interview represents the intelligent, pure monetarist argument for higher inflation. The type of thing that would have been perfect to pick apart on SMACKDOWN week!
For what its worth, I think Grant is a great writer and always an interesting read, though in recent years I think he’s become more and more of a lawyer. That doesn’t invalidate his argument, but it does tend to mean he seems less willing to consider possibilities away from his base view. I think its fair to say that Grant is generally against central bank intervention, particularly when it comes to stimulus. He comes from the school that thinks its necessary to keep money tight always and everywhere.
Here are a couple thoughts. First, Grant’s off-handed comment that the Fed’s balance sheet is as bad as Citigroup’s is just dumb, and he’s too smart to make that kind of comment. 54% of the Fed’s balance sheet is in Treasuries and GSE debt. Another 14% is in straight currency and/or gold. 37% are short-term repo/discount window type transactions, which are all overcollateralized, mostly with extremely high quality collateral. 5% is in Bear Stearns/AIG bailout-related assets. That’s the only realistic place where the Fed stands to lose money. Obviously Citigroup (C) doesn’t have such a high-quality list of assets. I said a few weeks ago that leverage alone isn’t the sole determinant of risk. Is Grant trying to argue otherwise? Asset quality doesn’t matter at all? Or is he just trying to throw a good sound byte out there?
He also comments that M2 is up 9% year-over-year, and that didn’t happen back in the Depression. I can just imagine Ben Bernanke sitting at home throwing up his hands yelling at his TV. “EXACTLY!!” The idea is to prevent the Great Depression right?
He goes on to say that he expects higher CPI prints, but admits that its possible that the Fed’s extra cash flows someplace besides consumer goods. That kind of thinking would be entirely consistent with my argument that consumer spending won’t rise, and yet still suggest that the Fed’s actions are problematic. In fact, I’d go so far as to agree that the cash must flow someplace. It is accurate to say that excess liquidity can and does lead to bubbles.
However, based on the data, I’d argue that the cash has all flowed into bank excess reserves. M2 is up $691 billion year-over-year. Excess reserves are up $836 billion. Is there a bubble in excess reserves?
I’d go on to say that once the cash starts to flow to consumers, they seem likely to save it. The savings rate is currently 5.7%. Household net debt has declined two quarters in a row now. If consumers see more money I’d think it would continue to flow this way. I don’t think that printed money turning into balance sheet repair should worry us all that much. In fact, I think its a pretty favorable outcome, allowing consumers to improve their debt position without causing economy-wide deflation.
The risk, as similar to what I outlined last week, is that consumers become satisfied with a level of balance sheet repair, and funds start flowing elsewhere. In order to avoid this, the Fed is going to have to pull back on their extraordinary programs quickly, and frankly, soon. We’ll see on June 24!