Why I think QE will create inflation and why it is qualitatively different than credit expansion

Meredith Whitney has come down hard on the municipal bonds and she is getting a lot of heat from others, including David Rosenberg.  But even if she is wrong, bonds of all sorts are bad investments because the US dollar is going to hell in a hand basket.  But what about shrinking credit which causes deflation?  I am no economist but here is why I think QE causes inflation while credit expansion is less inflationary:

Inflation is caused by too much money supply chasing too few goods.  Money supply can be created through credit expansion or through QE.  Credit expansion results in the creation of goods and services such as building of houses and manufactured goods, for every time a business borrows, its creates more real wealth in the form of its products.  Every time a home owner buys a house with a mortgage, the demand for new housing goes up and it results in larger supply of homes, i.e., more goods.  Thus, though credit expansion can obviously create bubbles, it also results in the increase of goods and services.

QE, quantitative easing, or the monetization of debt results in a disproportionate demand for goods and service without the creation thereof.  This is because the US federal debt is being monetized, and the US government in turn gives the money to government workers, pensioners, social security, welfare, food stamps, etc.  I.e. to people who increase demand without increasing the quantity of goods and services.  This increased demand, too many dollars chasing to few goods, devalues the dollar.

And this is why I think that QE leads to inflation and why it is much worse than credit expansion.

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2 thoughts on “Why I think QE will create inflation and why it is qualitatively different than credit expansion

  1. P.W. Dunn,
    I agree with you on the fact that QE will lead to inflation. However, as I pointed out in article very similar to this one,QE2 will decrease the value of the dollar->leading to an increase in American exports and a decrease in imports. Throughout history QE has not proved to be a sufficient way to boost the economy, but I am still optimistic about it.

    • Here is the link to the post you mention: http://wallstreetchalkboard.com/?p=42

      Well, hopefully your optimism is not entirely unfounded. I am expecting the worse. My portfolio is designed to take advantage of the collapse of the dollar: it is all Canadian, all in gold mining and oil, and I am even shorting the dollar–indeed, my US dollar carry trade is doing really well: I sell puts on CDN gold mining companies in my US margin account, on CDN oil and gas companies, and I maintain for the most part a negative cash balance.

      Part of the problem for the states will be that the factories have mostly closed down already. So it is not as if there is a sufficient manufacturing base still left in the country. Then, to manufacture goods, there are the costs of labor and materials. Materials will sky rocket, but labor will go down with devalued currency. So for a short time, exports might possibly benefit. But now in the US the regulatory and tax environment is unfavorable to business, as are the power of unions. Finally, if the economy meltdowns, this will be a deterrent to investment, until such time as restructuring occurs and the environment becomes healthy again. Until then, I’m afraid there is going to a lot of pain.

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