Watch that printing press

Mr. Kellner contemplates where the next bubble will form. In other words, where will all this money flow to? We believe a large portion of it will flow to gold & silver.

Watch that printing press

Commentary: Money supply will soar once banks loosen purse strings

By Irwin Kellner, MarketWatch
Last update: 12:01 a.m. EST Dec. 23, 2008

PORT WASHINGTON, N.Y. (MarketWatch) -- As 2008 draws to a close, one of our chief concerns is deflation. A year from now, the nation's No. 1 problem might well be inflation.
Last week's statement by the Federal Reserve indicated that, when it comes to interest-rate cuts, the central bank has gone about as far as it can go.

The Fed acknowledged that the actual federal funds rate was well below its target because it has injected massive amounts of liquidity into the economy. So it made this rate its new target, and said that it would concentrate instead on pumping gobs of money into the system.

Not that the central bank has been exactly resting on its oars.

On the contrary, according to the Federal Reserve Bank of St. Louis, the monetary base (the raw material for the money supply) has risen at a seasonally adjusted annual rate of 86% over the past year. Bad enough, but over the past three months this has skyrocketed to an annual rate of almost 1,000%!

Adjusted reserves have ballooned from $100 billion to $700 billion since mid-September, while the Fed's balance sheet has more than doubled over this period of time, from about $900 billion to a thumping $2.2 trillion.

These funds are beginning to show up in the Fed's two measures of the money supply. M2 has risen 8% over the past year, while MZM, the St. Louis Fed's measure of liquid money, is up more than 10% during the same period.

This is with the banks still reluctant to lend. Once they loosen their purse strings, the money supply will soar.

When this happens, don't be surprised if the Fed stops reporting these numbers. This is what it did several years ago, when it stopped reporting M3, which apparently was rising too fast for the Fed's comfort.

While virtually no one is raising prices in today's depressed economy, all this liquidity will soon become an accident looking for a place to happen.

While virtually no one is raising prices in today's depressed economy, all this liquidity will soon become an accident looking for a place to happen. The trick then, for the Fed, is to drain this excess liquidity before it turns into inflation.

This is easier said than done, because the Fed will have to begin weaning us off easy money long before the recession ends. By the way, this could happen sooner than you think.

Besides easy money, the sharp plunge in oil prices since midyear has put billions of (after-tax) dollars back into the pockets of consumers, business and governments -- by some estimates as much as $250 billion.

Add to this the $150 billion in tax rebates that Washington mailed out over the summer, and this economy already has received stimulus equal to almost 3% of GDP. When the new administration takes over in January, you may expect additional fiscal stimulus of as much as 5% of GDP.

Such a push could easily jump-start the economy -- right into another round of inflation.

For its part, the Fed may find it difficult to reverse course. This is because in the process of blowing up its balance sheet, the central bank has bought lots of instruments for which there are few ready buyers.

Thus we are likely to witness the formation of a new bubble, possibly as soon as a year from now. The question is where.

It will be a while before shell-shocked retailers and others try to raise prices. Oil is unlikely to go up either, in view of the imbalance between supply and demand. The same goes for housing. The jobless rate is likely to be too high to tempt labor to go for big pay increases (at least in most sectors).

But workers might have some leverage when it comes to rebuilding the country's infrastructure -- one of the president-elect's top priorities. In addition, prices of such commodities as steel, cement and construction equipment could also soar as tons of money land in this sector literally overnight. End of Story

Irwin Kellner is chief economist for MarketWatch, and is Distinguished Scholar of Economics at Dowling College in Oakdale, N.Y.

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