Chapter 5. Money and the Great Reflation

Inflation is always and everywhere a monetary phenomenon.

Milton Friedman and Anna Schwartz[34]

Investors are understandably concerned that the Great Reflation will turn into the Great Inflation. In this chapter, we look at some of the issues relating to those fears. In previous chapters we pointed out why inflation is the single most important factor affecting investments. We also emphasized that inflation should be understood as an increase in money and credit beyond the growth requirements of the economy. In the previous chapter, we explained how the implosion of the 25-year private debt binge is creating a government debt supercycle of its own. The explosion of government debt is one component of the Great Reflation. The other is money printing and near-zero interest rates. The Federal Reserve is the institution behind the monetary component, and it will play the starring role in whether we have another inflationary drama.

The Great Reflation experiment is pushing an avalanche of new money into the economy and financial system. This new money must find a home somewhere. By the end of 2009, the government had succeeded in its initial purpose of stabilizing the financial system, reflating asset prices, and generating economic recovery, albeit a hesitant and artificial one. However, being an experiment, the ultimate outcome of the total reflation package is far from certain. That is a reality that all investors must continuously keep in mind ...

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