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The following is a contribution by the anlysts at Annaly Capital Management:

Austrian business cycle theory is intensely focused on inflation as a byproduct of attempts by central banks to artificially stimulate the economy through the tools of monetary policy, i.e., lowering interest rates and increasing money supply. We have low rates, but money supply growth isn’t off the charts. Through December 21, 2009, the MZM monetary aggregate grew 4.7% year-over year and fell at an annualized rate of 1.9% over the last three months, and the narrower M2 grew 3.5% and 3.9% year-over-year and over the last three months, respectively. We do have, however, over a trillion dollars in excess reserves in our nation’s banks. Here’s a big assumption: Assume, for the moment (as many people are doing nowadays), that this is a proxy for the Austrian problem and therefore a precursor to inflation. Austrian economist Ludwig von Mises reminds us that inflation won’t be instantaneous or equal across all goods and services.  He said, “Changes in the structure of prices brought about by changes in the supply of money available in the economic system never affect the prices of the various commodities and services to the same extent and at the same date.”

According to this perspective, if the government were to print money there would be a general yet uneven increase in prices of goods and services. It hasn’t happened yet, but it still might, particularly if those reserves make their way into the economy rather than stay stuffed in the banks’ mattresses on deposit at the Fed (where the Fed wants to keep it by paying interest on it, or converting it into term deposits, or drain it through the repurchase markets). We would suggest that von Mises’ dictum is instead taking place in financial assets. Consider the government’s balance sheet expansion that began in earnest in September 2008. As the graph below illustrates, this move preceded surges in the prices of gold (arguably a financial asset), then high yield bonds, then stocks.

We don’t want to confuse liquidity with monetary stimulus. In the latter condition, the Austrians will likely be right. In the former-which we have now-bubbles are created as liquidity seeks out higher returns by going out the risk curve.

Source: Annaly Capital Management

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