The Fed’s Policy of Creating Inflation: A Massive Wealth Transfer
by Prof. Rodrigue Tremblay
February 16, 2011
“If once [the people] become inattentive to the public affairs, you and I, and Congress and Assemblies, Judges and Governors, shall all become wolves. It seems to be the law of our general nature, in spite of individual exceptions.” Thomas Jefferson (1743-1826), 3rd US President
“If the American people ever allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered.” Thomas Jefferson (1743-1826), 3rd US President
[Corruption in high places would follow as] “all wealth is aggregated in a few hands and the Republic is destroyed.” Abraham Lincoln (1809-1865), American 16th US President (1861-65)
“When plunder becomes a way of life for a group of men living together in society, they create for themselves, in the course of time, a legal system that authorizes it and a moral code that glorifies it.” Frederic Bastiat (1801-1850), French economist
“Inflation made here in the United States is very, very low.” Ben Bernanke, Fed Chairman, Thursday, February 10, 2011
Let us begin with some macroeconomic indicators of reference.
In October 2010, the world value of total production (all Gross Domestic Products or GDPs) was estimated to be $61.96 trillion U.S. dollars at current nominal prices. The U.S.GDP was estimated at $16.11 trillion or 26 % of world GDP. [ http://en.wikipedia.org/wiki/List_of_countries_by_future_GDP_(nominal)_estimates ]
The two largest financial markets in terms of trading values are the global foreign exchange market (all currency markets) that has an average daily turnover in global foreign exchange transactions of about $4 trillion per day, and the privately-traded and mostly unregulated world derivatives market (all the derivatives markets) whose total world outstanding contracts has been estimated by the Bank for International Settlements in Switzerland to have a notional or face value of about $791 trillion in 2010.[ http://en.wikipedia.org/wiki/Foreign_exchange_market ][ http://en.wikipedia.org/wiki/Stock_market ]
In terms of real wealth, however, the two most important financial markets are the world bond market [ http://en.wikipedia.org/wiki/Bond_market ] and the world stock market. [ http://www.world-exchanges.org/news-views/press-releases/-world-federation-exchanges-publishes-2010-market-statistics ] In 2009, for example, the global bond market had an outstanding value of $US 91 trillion, with the U.S. bond market, at a value of $US 35.5 trillion, being the largest domestic bond market. –In mid-2010, the global equity market capitalization on regulated exchanges was estimated at $US 54.9 trillion, with the U.S. stock market having a value of some $US 19.8 trillion.
With such a large amount of financial assets, it is understandable that shifts in prices and interest rates have important effects on each market. If long-term interest rates go up, the nominal value of bonds goes down, and conversely, when interest rates decline, bond prices go up. As for stocks, many factors, such as company earnings, future profit prospects and inflation expectations, as well as political and taxation considerations, can influence their value. However, in general, they tend to fare better when short-term interest rates are low rather than high.
Sometimes, these two important financial markets move up together, especially in an environment of general disinflation, when interest rates tend to decline. They also tend to decline in tandem when real interest rates
[ http://www.investopedia.com/terms/r/realinterestrate.asp ] are on the rise, both bond prices and stock prices are then falling.
Sometimes, however, they can move in different directions, especially in the early phase of an inflationary period, such unexpected inflation being good for the stock market but bad for the bond market. Since last fall, this has been case, with the bond market falling and the stock market rising. The question is how long this decoupling can last.
And how does the Fed’s monetary policy fit into such an environment of oncoming inflation, and what should the Fed do?