Tuesday, September 22, 2009

No Hyper Inflation -- Hyper Prosperity Instead!

In the 1970's, after a long period of negative real interest rates, the US experienced hyper-inflation. In the past year, our government has inflated its balance sheet while corporations and individuals have worked at paying down debt. The ballooning of the Fed balance sheet has caused many folk to believe a period of hyper inflation is coming. The following chart shows that conditions are not nearly the same as after the 1973-74 recession. Thus we can expect different results.

The important part of the graph is the yellow portion. This shows the difference in the fed funds rate and the inflation rate. At the end of the 1973-74 recession, the difference was negative and inflation soared. After  Paul Volker was appointed Chairman of the Fed in August of 1979, the situation begun to change. During his first 22 months in office, Volker took the nominal fed funds rates from 12% to 20%. Real interest rates went from negative 6% to positive 10%. Volker forced the US to take a strong dose of medicine to cure a debilitating disease. 

Former Chairman Greenspan has received considerable criticism for keeping real rates negative from 2001 to 2005. Some folk believe that he single handedly caused the housing bubble by keeping interest rates too low. There is much more to the story, but loose money did play a part.

The key understanding needed by investors today is that real rates have already turned positive; recently real short rates were at 1.66%. While it is true that inflation is a monetary phenomenon and that the Fed has printed money to lend to banks, conditions are not conducive to excessive lending by banks and the printing of money will not get out of hand in this environment. Indeed, banks tend to err on the side of caution for months and years after tough recessions.  

Only a year ago, resources were tight. Energy supplies and industrial metals were being bid up and even hoarded. Today, there is slack industrial capacity and abundant supplies of resources. Central bankers have many months to go before they need to drain the liquidity swamp. In the meantime, a major portion of the river of dollars that were flowing into Middle Eastern coffers are flowing into the build-out of high speed mobile communications. Verizon, AT&T and many others have moved into hyper development mode. Plans for next generation high speed mobile Internet have been accelerated.  The build-out is world wide. China Mobile just signed customer number 500 million!

Much waste is being perpetrated by government. For example, street cars are being added to cities that are successful in obtaining federal grants for 80 to 90% of the construction costs. How many years will we waste tax dollars on under utilized buses and street cars?  The good news for investors is that the America people are upset enough to speak out and to vote against additional wasteful spending. Government will not continue to consume such a high percentage of capital. Money will be available for private enterprise to take us to a new high level of prosperity.


karim said...

Very thoughtfull post on prosperity .It should be very much helpfull.

Karim - Creating Power