Been thinking a lot about inflation lately. As you know, people have become very concerned about inflation since Bernanke pumped 750B in cash into the economy. In my mind, there are 3 key questions coming out of this:
1.) How much, on a percentage basis, will the U.S. money supply eventually increase as a result of this?
2.) How long will it take for this extra money to actually drive up general price levels?
3.) How much will GDP grow between now and the time that the inflationary impact of the cash injection starts to kick in?
Answers and Explanation:
1.) In total Bernanke has loaned out 1 trillion dollars to commercial banks across the country. He also bought back at least 300 billion in treasury securities. Lets conservatively assume that because the loans are going to be repaid, they will have limited net impact on the money supply (1 trillion out of the fed, 1 trillion right back in next year). Its still not clear to me whether this is the right assumption or not (maybe someone can enlighten me), but its definitely a conservative assumption, unless you argue that the 1 trillion repayment will suck more out of the money supply than the 1 trillion dollar injection boosted it.
So, how does that 300 billion compare to the current money supply? Well, its about 40% of M0 (M0-currency in circulation) which is 750 billion, and its about 18% of M1 (currency + checking account deposits + commercial bank deposits with the federal reserve).
Assuming the 300 billion gets loaned out by the banks that sold their treasury debt to get it, it will increase M2 by 40% or more.
2.) I have no real idea how to answer this. I saw an interesting essay by Milton Friedman today about it in a book at the library ("essays on positive economics"). I'll revisit this in a later blog, but suffice it to say here that it will happen eventually, and my guess is that it will actually happen in the next 1 to 2 years.
3.) Make the extremely optimistic assumption that real GDP will grow 5% annually for the next two years (the time I am assuming it will take for the money supply increase to kick in).
Where does this leave us?
30% inflation over two years.
The important question is what a savvy investor should do about this. The immediate, possibly naivete answer is to buy gold, but there are lots of other options including:
1.) TIPS
2.) real estate or REITS
3.) equity in companies that will be the first to realize rising profits from higher prices
-I think this would be retailers or commodity stocks, not sure though
4.) commodity futures
5.) foreign currency or foreign currency denominated bonds or equities
6.) ...probably others
I plan on exploring all these options although my personal preference is for the equity options (3 and 5).
