I am saddened to say that John Hussman is worried about inflation and default in the USA. I guess the inflationistas and defaultiastas have made a substantial mid-season pick-up. Unfortunately, however, Mr. Hussman makes all the same claims that have driven these worrywarts astray for so many years. Specifically, Mr. Hussman is now discussing the inevitable “collapse” of the U.S. dollar due to Quantitative Easing. He writes:
“A week ago, the Federal Reserve initiated a new program of “quantitative easing” (QE), with the Fed purchasing U.S. Treasury securities and paying for those securities by creating billions of dollars in new monetary base. Treasury bond prices surged on the action. With the U.S. economy predictably weakening, this second round of quantitative easing appears likely to continue. Unfortunately, the unintended side effect of this policy shift is likely to be an abrupt collapse in the foreign exchange value of the U.S. dollar.”
Of course, regular readers know that this is simply not true. There is substantial historical evidence showing that QE is nothing more than an asset swap and has little to no impact on the real economy, inflation rates or currencies. Japan is again the best historical precedent. The BOJ initiated their policy of QE in March of 2001 and continued to stock the shelves with more apples for 5 full years. Over this time the Yen actually remained quite strong despite a weak economy and zero percent interest rates. Over these 5 years the Yen experienced no substantive weakness and actually finished marginally higher in 2006 when the program was finally wound down and the BOJ admitted that QE was a non-event:
“QE’s effect on raising aggregate demand and prices was often limited” (Ugai, 2006)
For a more pertinent and timely example we can look at our own currency. The US Dollar has been remarkably strong over the last few years despite all of this “money printing”. In a performance eerily similar to the Yen during their period of QE the dollar is roughly flat since the Fed went on their shelf restocking campaign. Despite this, interest rates have continued to decline and the dollar has remained relatively strong. It is the exact opposite of what the hyperinflationists and defaultistas have all been telling us would happen.
Hussman continues by saying that we are essentially running out of money in the USA, “printing money” to compensate for our mistakes and that inflation is the long-term threat:
“quantitative easing can be expected to create a remarkably different situation. The Fed’s purchase of Treasury securities and creation of base money is occurring in an environment where fiscal deficits are already out of control, while two-thirds of the Fed’s balance sheet already represents Fannie and Freddie Mac securities that need to be bailed out by the Treasury. This makes it enormously difficult to reverse the Fed’s transactions – because the Fed is not simply determining whether a given stock of government liabilities will take the form of Treasury bonds or currency. It is instead effectively printing new money to finance ongoing spending for fiscal deficits and the bailout of the GSEs. At the same time, the fact that it is operating in a weak economy and a near-term deflationary environment means that nominal interest rates are being pressed down at the same time that long-term inflationary prospects are escalating.”
I don’t necessarily disagree that there is a long-term threat of inflation or that we have attempted to paper over many of our mistakes, however, there is very strong evidence showing that QE will not be the cause of a collapse in the dollar. Without rehashing all of the points I have made previously, I think Mr. Hussman’s thoughts can be best summed up with the four most dangerous words in the investment world:
“It’s different this time”.