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(snip)"The real threat of inflation, decreasing foreign reserves: Why the US should expect 8% inflation for the next three years
Weekly we put out information on the US Dollar Money supply. Current M2 money supply is over 9 Trillion dollars.
This is a good proxy for money growth and good predictor of inflation except for one crucial flaw.
There is some money which is printed, but does not make it into the money supply. Consider the scenario that the Fed prints a dollar that is then either lost or destroyed. It then cannot be used to buy goods, or be lent out and thus does not create inflation.
There is something else which can happen to our money which has the same net effect. Foreign central banks can take cash printed from the Fed and place it on their balance sheet. US dollars on foreign banks balance sheets gives investors confidence that their own currency will not be debased.
In our current (weakening) dollar regime, the US dollar is the main foreign reserve currency. When foreign central banks put US dollars onto their balance sheet, they take them out of circulation. They are not being used to buy goods. These dollars are not lent out. As such, they do not create inflation.
Americans have benefitted greatly from having [ foreign - sic ] central banks prefer our cash to even their own. It has allowed the Fed to print money like mad without the fear of inflation.
In other words, the real threat of inflation is not the current printing of money which Bernanke et al have been doing. It is the previous printing of money which has been taken out of circulation. The threat is as great as its ever been. The amount of money in foreign reserves is about one third or more of M2, or every dollar which is held by US bank account (business or retail), and all currency combined.
There are signs that this dollar regime will be ending. The cracks have been apparent for some time, but we just blew a big hole in the US Dollar dam. This week, China has announced that they will reduce their US dollar holdings by more than 1.7 Trillion Dollars.
Via Xinhuanet:
The amount of foreign exchange reserves should be restricted to between 800 billion to 1.3 trillion U.S. dollars, Tang told a forum in Beijing, saying that the current reserve amount is too high.
China's foreign exchange reserves increased by 197.4 billion U.S. dollars in the first three months of this year to 3.04 trillion U.S. dollars by the end of March.
1.7 Trillion dollars is the amount that we have added to our money supply since August 2007. If all that money were to come into the current US money supply all at once it would increase money supply by 19%. That would make US inflation among the highest in the world.
If this action were to be followed by other central banks in Japan or Europe, there would be a real danger of hyperinflation to the tune of 50%.
Now, odds are they won't do this all at once. That is why we have said that at least the amount of inflation, should it be spread out over 3 years should be 8% or more.
See the total allocated and unallocated foreign reserves above. You can see that the US Dollar, is the king right now, but the Euro is gaining. What is gaining even faster is the Unallocated foreign reserves, which means it is either in something else (gold, or IMF certificates), or they don't want to disclose.
Either way, it should be concerning to anyone who has money in dollars... very concerning.(snip)
The author's point is well taken ... that additional US dollars held as foreign exchange reserves by foreign governments has basically acted as a 'sponge' to soak up newly printed dollars, and thus has already taken a good number of those newly printed dollars out of the total circulating US dollar money supply ( in the same way as if fewer dollars had been printed). This 'sponge' action has allowed the US gov't to spend newly printed money with comparatively little inflationary effect. However, when those foreign governments decide they no longer wish to hold those US dollars as foreign exchange reserves, those US dollars will immediately flow back into the total circulating US dollar money supply thus causing massive inflationary effects.
The author's less obvious point is that even if US policy regarding the relentless printing of new US dollars were to change, i.e. that the FED's QE2 program would be allowed to die as scheduled at the end of June, that the US Treasury were to stop printing up new US gov't bonds etc., that future inflationary effects would still continue due to the (partial ) liquidation of US dollar foreign exchange reserves already held by foreign gov'ts. Thus the author's conclusion is that America will see major inflation effects over the next several years even if the current US gov't inflationary policies are terminated.
If the author's total monetary estimates and three year scenario are accurate, this will basically translate into a -1.08 * -1.08 * -1.08 = -1.26 or 26% reduction in the 'purchasing power' of the average American three years from now ( even though they will still be earning the same number of US dollars ) thanks to US dollar price inflation. If true, this is VERY bad news for anyone whose income depends on the 'discretionary spending' habits of Americans i.e. exotic dancers. This is also bad news for anyone who is holding long term fixed value US dollar denominated investments i.e. bonds or CD's.
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