Opinion

THE COMING INFLATION CRISIS

If you don’t understand the profound importance of the Federal Reserve’s decision this week to purchase $300 million of US long-term debt, consider the words of savvy Wall Streeter Ben King: It’s the “nuclear option . . . commence the Weimar Watch.”

We all know what happens when a nuclear bomb goes off, but people younger than 60 may not recognize the Weimar image of Germans before WWII pushing wheelbarrows of currency to make ordinary purchases. Hyperinflation and the collapse of that country’s currency led to the rise of the Nazi Party.

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Nobody is saying this is going to happen in the US yet. But the Fed’s decision last week to, essentially, print $300 billion of currency on top of the ever-increasing trillions we already have as a country in new and old debt certainly makes something like Weimar more possible today than it was last week.

How’d we get to this point? As King points out, “In a word: China.”

The US has been running up debt for more than half a century, but never at the current pace. Early on, when the world was a smaller place, Washington mostly borrowed what it needed from Americans. It was like a friendly loan among family nobody worried about getting screwed. Hollywood entertainers and sports stars helped the US sell its bonds during WWII. It was, at the very least, a quaint, patriotic gesture to buy these bonds. And sometimes it wasn’t even a bad investment.

But the financial world has gotten smaller and Washington continued to need more and more borrowed money to fund its expanding programs. Today this country’s overall debt exceeds $11 trillion and it is rising quickly.

Nowadays, a lot of our debt is purchased by foreigners, including the government of Japan and the members of OPEC cartel. Some of these lenders are friendlier to America than others.

But friend and foe alike believe America has always been seen as a stable nation that will pay its IOUs and, above all else, will not let the value of its currency deteriorate because of reckless financial moves.

China has been the biggest investor in the US in recent years. The country, which is friend or enemy depending on which way the political wind is blowing, today holds about $1 trillion in US assets. Like any investor, the Chinese don’t want to lose money. But with the US economy tailspinning and Washington writing a game plan for recovery as it goes along, Chinese Premier Wen Jiabao said last week that he was a “little bit worried” about the assets his country has in the US.

That statement packed a wallop, since Washington is counting on China as well as other foreign investors to keep purchasing billions of dollars bonds that will have to be sold in the months ahead to pay for the economic stimulus package that the Obama Administration and Congress recently passed.

Is Premier Wen simply being a fussbudget? Or, perhaps his statement was payback for all the times we preached capitalism and human rights to the People’s Republic? Maybe a little of both. But China also has legitimate concerns.

Each dollar the American government prints essentially makes the dollars already in circulation in your pocket and in the Chinese investment portfolio worth a little less.

In the 24 hours after the Fed’s announcement last Wednesday, the value of the US dollar compared to a basket of foreign currencies fell around 4.25%. So if the Chinese had decided, for instance, to cash in their bonds on Thursday and bring the money back home, that country’s assets would have fallen 4.25% on the change in the relative currency values alone.

If foreigners bolt the US markets, Washington’s only other alternative would be to crank up the printing press even more and create billions in new currency that could lose its worth on the international markets.

If the dollar continues to drop Americans will have to pay more for foreign products, whether cars from Japan, electronics from China or oil from the Middle East. And while a depressed US economy might keep prices of domestic goods down, inflation could rear up at the slightest sign of an economic recovery.

Worse, if foreign investors decide that investing assets in the US has suddenly become too risky, then interest rates will have to climb to attract overseas capital.

In other words, experts worry that the actions being taken today especially the revolutionary idea of Washington becoming an important buyer of its own bonds could lead to a situation where rising inflation and climbing interest rates make it impossible for the US economy to recover.

Chairman Bernanke is clearly aware of the risks. Way back in 2002, when he was a mere professor at Princeton heading to the Fed, Bernanke said hypothetically that he’d run the printing presses if he was in charge and prices started to deflate.

With real estate and stock prices wiping out trillions of dollars of American’s net worth, Bernanke is now facing in the real world what he once thought was merely a theoretical exercise.