The major stock markets have now been rallying higher since early June 2012 on the speculation that bailouts would occur in Europe and the Federal Reserve (U.S. central bank) would implement another round of easy money policies called quantitative easing. Well, as we know both are true and are taking place right now. First, the European Central Bank (ECB) is buying European debt keeping bond yields artificially low on sovereign debt. This move has actually helped to strengthen the European stock markets. Second, the Federal Reserve implemented it’s latest round of stimulus and easy money called QE-3. This is where the central bank will buy $40 billion worth of mortgage back securities (MBS). This has certainly helped to inflate the stock and commodity markets sharply higher.
The big question that traders, investors, and the public are probably wondering is where does this money come from that central banks such as the Federal Reserve and the ECB use to buy all of this debt. Well, the money is basically created out of thin air by the central banks. So basically, if your next door neighbor is about to go bankrupt you as a good neighbor can help them out by just creating more money magically out of thin air. This money can then be given to you friendly neighbor and they can continue to spend and live their life happily ever after. Well, it’s not exactly that simply, but is is pretty close. You see, all of the money that is printed is backed by the U.S. consumer who will have to pay interest on that money that is being printed. So, all is well again when money is printed by the central banks. Not so fast, there is always a price to pay for easy money policies.
Inflation is created when money is printed. Everyone in the investing world can easily see how fast the base metal stocks such as Freeport McMoRan Copper & Gold Inc (NYSE:FCX), and Southern Copper Corp (NYSE:SCCO) have surged higher on the anticipation of the QE-3 announcement. Gasoline prices have skyrocketed higher along with many food products that are priced in U.S. Dollars. The value of the U.S. Dollar Index has dropped by more than 6.0 percent since late July 2012. This is inflation, plain and simple.
Inflation is good in some cases as it props up asset prices. Everyone loves to see their stocks and their 401K’s inflate and trade higher. The problem is that inflation is a direct tax on the people because all of the goods and products that people need become more expensive. If the past and in current times there are countries facing something called hyper-inflation. According to Wikipedia, hyperinflation occurs when a country experiences very high and usually accelerating inflation. Hyper-inflation is now taking place in countries such as Zimbabwe, and Iran, but can it happen in the United States, England, or another developed nation? The answer is yes, it happened to Germany and to numerous South American countries in recent history and it will happen again.
The U.S. Dollar is the world’s reserve currency at this time. That means that most all commodities such as oil, gold, copper, wheat, and others must be traded in U.S. Dollars. Many countries such as Russia, Brazil, and China are now looking to trade without using the U.S. Dollar. This could be problematic for the U.S. Dollar and the United States in the future. Currency wars are starting to brew up around the world and this will eventually lead to unstable markets again. Should and if this happens, the central banks will start to lose their power and frankly, all hell could brake loose. The bottom line, this current money printing by the central bankers is unsustainable. Sure, inflation rallies could last for another year or two, but it will end the same way that it has ended been in the past, in disaster.
So, enjoy this game of musical chairs for now while we live in the land of make believe. One day, these central bankers will eventually have to wake up and realize that supply and demand needs to control the markets not money created by a click of a computer button.