The Folly of Assuming Anything

If anyone tells you that they know how this election cycle is going to run, assume they are fools. A couple of financial morsels to chew on this morning. First, the Greeks get the bad news:

Greece’s credit ratings were cut to “Selective Default” by Standard & Poor’s after it negotiated the biggest sovereign debt restructuring in history. 

S&P dropped Greece’s rating from CC, two levels above default, after the government added clauses to its debt designed to mop up investors unwilling to take part in the exchange, the New York-based company said in a statement today. 

The downgrade follows a reduction last week by Fitch Ratings to C, while Moody’s Investors Service has said it will cut the nation to its lowest rating.

All the restructuring in the world isn't going to change the facts. The Greeks are headed into something that will be very, very bad. Meanwhile, how does 15% inflation in the U.S. strike ya?

The annual inflation rate in the United States could hit 15% by late 2013 or early 2014, and the Federal Reserve may be powerless to stop it. 

While much can change the risk of inflation, the single most important driver of a rise in the general price level is the relationship of the money supply to economic activity. 

Since the economic meltdown began in 2008, the Fed has pumped an unprecedented amount of money into bank reserves. In 2011 alone, adjusted bank reserves increased at a compounded annual rate of 47.1%. As these bank reserves filter into the business and consumer economy, the risk of inflation rises.

Why would this happen? Let IBD explain:

Banks are currently holding about 15 times more than the roughly $100 billion in reserves required by the Fed, or $1.5 trillion. Historically, banks — which make profits primarily by lending out money, not keeping it — have held only 1% or 2% over required reserves.

Even at the current lending rate, the money supply has been growing faster than the economy. In December 2011, M2 — the money supply measure that includes currency, checking accounts, savings accounts, money-market mutual funds, and traveler's checks — grew at a year-to-year rate of about 10%. The U.S. economy during this period grew at 2.8%. 

Assuming no changes to the financial or payments system, this translates to a potential inflation rate of 7.2% (10% less 2.8%). This is basic monetary policy arithmetic. But it only considers money currently in circulation. Given the current volume of bank reserves, more money is certain to enter circulation, increasing the risk of even higher inflation.

Someday we're going to look back at what Ben Bernanke has been doing and realize how horribly he has performed.