Webster’s New World Dictionary: College Edition, 1970
an inflating or being inflated. 2. an increase in the amount of money in circulation, resulting in a relatively sharp and sudden fall in its value and rise in prices
Merriam-Webster’s Online Dictionary, 2012
a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services
As you can see, the definition of inflation has changed over time. Since inflation is the expansion of the money supply, and the FED is the source of the money supply, then the FED is by default the source of inflation. The problem is that the FED believes, and would have us believe, that inflation is rising prices. Additionally, the FED acts as if prices are something they can dial around like a thermostat. We contend that inflation, in the traditional sense, is here and that it will only take a lack of confidence in the US dollar to speed-up price levels. With the ongoing money printing in the US, we are not sure when the global economy will say enough is enough with the devaluation of the US dollar. The big concern here is if confidence is lost in the FED’s management of the US dollar. A loss of confidence will cause the velocity of money to pick up through people spending depreciating dollars faster. At this point, the Fed would be forced to raise rates at what will likely be an inopportune time.
FED’s Balance Sheet
When the FED purchases assets like US treasury bonds and mortgage backed securities, it is adding those as assets on its balance sheet. Keep in mind for the FED to purchase assets, to add to its balance sheet, it must create new money. This is a point where it is important to remember the above definition(s) of inflation. As more US dollars are created, the trillions of dollars already in circulation lose purchasing power.
An important item to keep in mind is that the FED’s balance sheet has already expanded by
227% since August of 2007. It is bad enough that the FED is running unprecedented balance sheet and economic experiments. But, the results from such extraordinary efforts have been less than sub-par.
Implications of the recent FED decision and policy change
So, what does all of this mean to the average investor? Here are a few points we think are important:
- Vague numbers – While everyone is looking for unemployment to drop, the fact is unemployment can drop, but employment can go down or hold steady at the same time. In the current trend, we are seeing people falling off the unemployment numbers and not turning up in the employed column; rather, they are falling out of the labor force. So, the unemployment figure could look better but the employment figure and economy may not (and has not).
- Watch what you wish for – Let’s assume unemployment meanders or plummets to 6.5%. The FED now has its wish and starts the process of raising interest rates and selling down its outsized assets. The economy would have to be going at a rip roaring pace, that we have not seen in a decade, for a rise in rates not to slam the breaks on the economy, and thereby the stock market. In addition, a rise in rates will negatively affect the bond markets since interest rates and bond values are move inversely. In other words, a rise in interest rates, at the wrong time, could bring the stock and bond market lower at the same time. The implication of stocks and bonds falling in tandem is the removal of a significant investment safe haven – bonds. This point is a big reason we are cautious on the investing markets and remain tactical in our approach to equities. The very data point we are all hoping to turn (jobs) could very easily lead to an economic and market obstacle.
- Hold on to your wallet – As indicated in the opening of this report, expanding the money supply is inflation (i.e., rising prices). So far the US has successfully exported a lot of inflation to the rest of the world through a currency war. We are seeing prices rising on energy, food, commodities, healthcare, and college tuition, but not as much on everyday household items. Inflation often works slowly at first, then all of a sudden. Continuing to create more and more money, at some point, may cause the markets to lose confidence in the ability of the US dollar to hold value. At that point, the FED will no longer control interest rates and the dollar would lose value quickly. This is why we have stressed to our clients the need to focus on maintenance of purchasing power through investments in real assets such as precious metals and certain areas in stocks.
The bottom line is that the recent FOMC decision, tying policy to particular data points, as well as the level of unsterilized money printing, is not only unprecedented but an indication that the FED is going to keep their foot on the currency debasement pedal. It would be foolish to think that such radical decisions, that appear to have little positive effect on the economy thus far, are not going to come without consequences. For this reason, we will continue to be vigilant in protecting our clients’ wealth and the purchasing power of that wealth.
Do you have an investment strategy that seeks to protect your portfolio against volatile economic conditions? Call me to schedule a free review of your current investment portfolio – 913.402.6099.
John P. Chladek, MBA, CFP® is the President of Chladek Wealth Management, LLC, a fee-only financial planning and investment management firm specializing in helping families and couples who are not yet retired realize their financial goals. For more information, visit http://www.chladekwealth.com.