By insisting on bailing out bank bondholders to the tune of 100 cents on the dollar, John Hussman says, the government has crowded out $1 trillion of private investment and almost guaranteed double-digit future inflation.
Hussman’s weekly note explains the crowding-out part in detail (it’s complex, but important). Here’s a quick summary:
Bailed-out banks are not pumping new cash into the economy. They are dumping crap assets onto the Fed’s balance sheet in exchange for cash, which they are then using to buy newly-issued Treasuries. The banks don’t have any more cash than before: They just have safer balance sheets than before. No new cash is being put to productive use in the economy. The government is just borrowing more to bail out bank bondholders who gave the banks money to blow in the first place.
So what does this mean?
The Treasury has issued an enormous volume of debt into the frightened hands of investors seeking default-free securities. This has allowed the Treasury to finance a massive and largely needless transfer of wealth to bank bondholders so easily over the short-term that the longer-term cost has been almost completely obscured.
But by transferring wealth from those who did not finance reckless loans to those who did – providing monetary compensation without economic production – the bureaucrats at the Treasury and Federal Reserve have crowded out more than a trillion dollars of gross investment that would have otherwise have been made by responsible people in the coming years, shifted assets to the control of those who have proven themselves to be irresponsible destroyers of capital, and have planted the seeds of inflation that will cut short any emerging recovery.
What will that inflation look like? A couple of years of uncomfortably high 5%-6% per year? Nope.
[T]he bailout ensures that any incipient recovery will be cut short, because the only reason that our economy is able to absorb the present supply of government liabilities is extreme risk aversion that creates a demand for default-free instruments. If that risk aversion abates, it will quickly be replaced by higher short term interest rates, higher monetary velocity, and inflation that can be expected to be quite difficult to control. At that point all the Fed will be able to do is to swap one government liability (monetary base) for another (Treasury securities). The genie will not easily go back into the bottle.
[T]he attempt to save bank bondholders from losses – to provide monetary compensation without economic production – is not sound economic policy but is instead a grand monetary experiment that has never been tried in the developed world except in Germany circa 1921.
This policy can only have one of two effects: either it will crowd out over $1 trillion of gross domestic investment that would otherwise have occurred if the appropriate losses had been wiped off the ledger (instead of making bank bondholders whole), or it will result in a stunning and durable increase in the quantity of base money, which will ultimately be accompanied not by a year or two of 5-6% inflation, but most probably by a near-doubling of the U.S. price level over the next decade.
The other way of saying “a near-doubling of the U.S. price level over the next decade” is “The value of your savings will be cut in half over the next 10 years.”
Skyrocketing inflation is generally not conducive to bull markets in stocks (see the 1970s). Stocks are, however, real assets, and as such, they will eventually shield you from the the impact of inflation.
Read John Hussman’s full note here >
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