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Subject:  a SNIP on the inflation theme Date:  9/27/2012  1:55 PM
Author:  grier22 Number:  44574 of 44633

This article 'Inflation and debt' is liberally quoted in the latest Grant's Interest Rate Observer. Like Pimco and GMO, the author is offering rationale to prepare for inflation. I keep wondering if the prospect of inflation, however distant, means we don't get the deep pullback Hussman is concerned about ('worst .5%' of all times to invest' according to his data). Inflation may be years away, or not.
But will institutions take advantage of any market weakness to gird themselves against the prospect?

The key reason is that our government is now funded mostly by rolling over relatively short-term debt, not by selling long-term bonds that will come due in some future time of projected budget surpluses. Half of all currently outstanding debt will mature in less than two and a half years, and a third will mature in under a year. Roughly speaking, the federal government each year must take on $6.5 trillion in new borrowing to pay off $5 trillion of maturing debt and $1.5 trillion or so in current deficits.

As the government pays off maturing debt, the holders of that debt receive a lot of money. Normally, that money would be used to buy new debt. But if investors start to fear inflation, which will erode the returns from government bonds, they won't buy the new debt. Instead, they will try to buy stocks, real estate, commodities, or other assets that are less sensitive to inflation. But there are only so many real assets around, and someone has to hold the stock of money and government debt. So the prices of real assets will rise. Then, with "paper" wealth high and prospective returns on these investments declining, people will start spending more on goods and services. But there are only so many of those around, too, so the overall price level must rise. Thus, when short-term debt must be rolled over, fears of future inflation give us inflation today — and potentially quite a lot of inflation.
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