QE2, QE3, Inflation, and Cooking the Books

by JDH on June 25, 2011

Let me see if I understand what’s going on at the moment.

QE2 is supposed to end at the end of June, so the Fed will not be buying treasuries. The U.S. government is running massive deficits, so they need to borrow money to operate. Presumably at some point in the near future the government will be raising the debt ceiling, again, allowing them to borrow even more money. If the Fed isn’t buying treasuries, and if the government needs to sell T-Bills to finance the deficit, they will have only once choice:

Raise interest rates to encourage suckers foreign investors to buy Treasury Bills.

Unfortunately rising interest rates will act to slow down the economy, just as the removal of liquidity now provided by QE2 will also slow the economy.

A slowing economy in advance of the presidential elections in 2012 is not good for the incumbents, so presumably something will need to be done well in advance of November 6, 2012. So, that would lead to the supposition that at some point in the late summer, or fall, or early winter of this year the Fed will have no choice but to commence QE3.

Interest rates are one issue; inflation is the other. As more dollars are printed, you have more dollars chasing the same number of goods, and that’s inflation (an increase in the money supply), which we observe as an increase in prices.

Our pals at the Fed mentioned the word inflation eight times in their 416 word June statement. They realize the economy is in a mess, as the quotes will demonstrate:

  • the economic recovery is continuing at a moderate pace, though somewhat more slowly than the Committee had expected.
  • …recent labor market indicators have been weaker than anticipated.
  • The slower pace of the recovery reflects in part factors that are likely to be temporary, including the damping effect of higher food and energy prices
  • investment in nonresidential structures is still weak, and the housing sector continues to be depressed.
  • Inflation has picked up in recent months, mainly reflecting higher prices for some commodities and imported goods…

All of those quotes were taken from paragraph #1 of their report. To sum up:

We have a “recovery” that is happening more slowly than expected (after spending trillions of dollars to get it going), which is why the unemployment rate in the U.S. remains at 9.1% (near the highest levels of the past 50 years).

The Fed thinks these problems are temporary, which is true, if you consider “worst levels in 50 years” to be “temporary”.

Part of the problem is higher food and energy prices, but that’s not a big problem, because of course very few of us actually use food or energy…. However, they do admit that inflation has picked up in recent months,

Oh yeah, let’s not forget that housing sector continues to be depressed.

So, in summary, we are in a depression, and inflation is increasing, which will erode whatever wealth we have built up.


If only there was a solution to these problems.

One option would be to cut spending, balance the budget, and convert to a non-fiat currency, but of course that would lead to temporary suffering during the adjustment phase.

So here’s an idea: let’s just change the way we calculate inflation, so that there isn’t any! It’s pretty simple, really. We all know that when prices go up we spend less, so let’s just reduce the basket as prices increase.  Yup, let’s cook the books!

For example, if today we assume that an American family buys 100 gallons of gas in a month, and the price is $4 per gallon, Americans spend $400 per month on gas. If the price of gas increases to $4.10 next month, Americans spend $410 on gas, which is an inflation rate of 2.5%.

But wait! Let’s assume that for every 1% increase in price, consumption drops by 1%. So now, at $4.10, Americans only buy 97.56 gallons of gas in a month, at $4.10 per gallon, for total spending of $400. That’s the same spending as last month, so bingo, no inflation.

This is a perfect plan. Since government payouts for social security, unemployment insurance, pensions, etc. are indexed to inflation, if there is no inflation, government payouts don’t go up. If there is inflation but we pretend there is no inflation, government payouts in real dollars actual drop. It’s brilliant. The Republicans will support it because it’s a reduction in government spending. The Democrats will support it because it’s not a tax increase (well it is, but it doesn’t look like one).

And who gets screwed? The little guy, who will have less real money to buy food, or put gas in his car, or live.

So there you have it. The Fed admits we are in a depression, and it’s worse than they expected, but rather that real change, the answer will be to change the way we crunch the numbers so everything looks great.

In the short term the U.S. Dollar will rally, because the end of QE2 will be perceived as good for the dollar (and all of the other major world currencies are in worse shape, so where else would you want to invest; Greece?). Gold may slip over the summer as a result of money flowing from gold back in to U.S. dollars.

But as summer follow spring, so to will QE3 follow QE2, and the house of cards will eventually collapse.

It wouldn’t surprise me at all if major players like China and Russia decided to stop using U.S. dollars, because who wants to use something that is guaranteed to decline in value. Oh wait, they just announced that Russia, China sign deal to switch to trade in rubles, yuan. (Thanks to onlooker on the BHSH Forum for pointing this out).

Hold your physical gold, hold some cash to use to purchase bargains when they appear during the summer, and stock up on physical goods before inflation takes off.

How’s that for an optimistic view of the world?

Thanks for reading; see you next week.