Thursday, May 5, 2011
QE, inflation and walking under ladders. What these things have in common.
We've heard many so-called experts say that Quantitative Easing causes inflation because the Fed is "pumping the economy with money."
We know this is not true and that whole notion has been debunked here many times.
However, just from the standpoint of common sense one should understand that there is no connection between QE and inflation.
Why would someone who has been sitting in a safe and secure gov't bond suddenly turn around and invest those proceeds in something as speculative as commodities? Maybe on the margin some of that is going on, however, it is not going on in any size that would cause the runnups in materials prices that we have seen.
Moreover, it is important to remember that the Fed conducts monetary operations (buying and selling of securities) with the primiary dealers and it is the primary dealers who sell to the Fed. This makes them "short" and since they need inventory at all times to meet the demand from their customers, they turn right around and cover those shorts by buying government bonds again in the next auction or whatever. (BTW, that's why the auctions go off so well all the time. The Fed has provided the funds.)
The money going into commodities right now is cash that investors and hedge funds have been sitting on and they put it to work ON THE BELIEF that QE causes inflation. You can equate it to the behavior of people walking around ladders rather than under them, because they believe that walking under them is bad luck.