The return of inflation

Although the precious metals have sold off in the past week, with gold down 10% and silver somewhat more, this is just a normal correction, as no market goes straight up. I think the next few months will show seasonal strength for both metals. We have had all of the ingredients for a bull market for the past decade now, and the case is only getting stronger.

In addition to declining mining supply and increasing monetary demand from investors, it is becoming harder and harder for mining companies to find new deposits to replace their reserves. On top of everything else, the new U.S. government is embarking on fiscal stimulus to break the bank. Some of it may be the infrastructure that we need, and some of it may be the (pork) spending programs that the Democrats have wanted for the past eight years. Any way you look at it, we can't afford it.

Ben Bernanke is of the opinion that we need to flood the system with money right now to avert the fiscal crisis, but that the liquidity can be withdrawn from the system once the crisis has passed. I don't know if he honestly believes that, or he is just being political, but if that is somehow possible, I wish someone would explain to me how it works.

The government has to fund its operating expenses by issuing Treasury bonds. Unfortunately, the gullible foreigners who used to buy them (Japanese, Chinese, Arabs, etc.) now have so many T-Bonds that they can't or won't buy as many as we need to sell. So they government has to sell the unsold bonds to the buyer of last resort: the Federal Reserve.

Uncle Ben's Fed has the luxury of a printing press, and can create all the currency (or in this case, digital money) it needs to buy every last unsold T-Bond. And if you've taken a look at the Fed's balance sheet lately, you'll see that it has done just that. It is swollen with not only T-Bonds, but also the impaired mortgage-backed securities that it swapped with insolvent banks for, to keep them from looking too obviously bankrupt.

So when the day comes that Prof. Bernanke decides the crisis has passed, banks are lending, business is booming, he will attempt to put the genie back in the bottle. To drain liquidity from the financial system, he will have to sell the Fed's T-Bonds, and send the cash proceeds back to whatever dimension the money was conjured from. The part I'm missing is how he is going to sell the T-Bonds. They are in what is commonly known as an "Owl" market.

An Owl market is when you call your broker, and tell him to sell, and he says, "To Whoooooom? To Whooooom?" Never mind the toxic junk that's worth pennies on the dollar, just think about the 10-year or 30-year T-Bonds that pay 3% interest. When inflation is raging, who will want to be locked into earning 3% interest for the duration? The simple fact is that T-Bonds are the last remaining bubble, and everyone knows it. Everyone wants to sell them, but to do so would collapse the market and send interest rates skyward.

Did you ever squeeze too much toothpaste out of the tube...and then try to put it back in? So good luck, Ben, when you try to sell those bonds and drain liquidity out of the system.