After QE3 Inflation Measure Jumps

Today's FT (Septermber 18, 2012) reports a jump of the market expectations for the US inflation. I have found a nice chart on bloomberg.com of the development of expected inflation (calculated using 5-year treasuries):

Break even rate: difference between the yield of treasuries and the inflation protected treasury debt

The FT sports another graph over a longer time period:
 

 The market sees a higher risk of increased inflation over the coming years because of the ultra expansive monetary policy of the Fed (QE3). The Fed seems to focus more on unemployment than on inflation. Accordingly the US Dollar traded lower and gold higher.

On June 3rd, 2012 the FT reported an even worse development taking place in secret:
Debt cancellation by central banks 
US, UK and Japan's central bank would cancel government debt on their balance sheet to reduce the outstanding government debt:

Just look at the amounts. They are just breath taking! What this means is a permanently increased monetary base, which will lead to higher inflation, if the central banks cannot take the liquidity out of the system in due time. Remember that there is a significant time lag of six months between central bank action (e.g. raising interest rates) and its effect on inflation.

I guess the Euro area will face inflation too, since Mr Draghi's recent declaration go in the same direction.

Investors have to protect themselves against these inflationary risks: long term bonds will be hit hardest. Stocks will also be hit, should inflation be above 4.5%. Only gold, commodities, and maybe real estate as well as gold mining stock will provide cover.

An overview of the macroeconomic challenges the  U.S. faces:

1. The financial crisis of 2008 is similar to the 1929 crash. As a consequence, we are lucky that we have no global depression and deflation. Therefore, it is justified to pursue an expansionary monetary policy in order to ensure that no deflation will take hold.
2. Monetary policy alone cannot boost the economy in a severe recession / depression, because of the so-called liquidity trap, according to Keynes. Expansive monetary policy does not work because "pushing on a string" does not work. Effective demand-side policies are much much more effective in the aftermath of a financial crises. Tax cuts (the supply side) will not help because they do not drive consumption. Joseph Stiglitz argues in his book Freefall against the of trickle-down theory, and the invisible hand of Adam Smith (the hand is so invisible because it does not exist). However, the U.S. is now too indebted to initiate further big stimulus programs. In addition, U.S. citizens must first rebuild savings, before they can increase consumer spending.
3. In recessions / depressions psychological factors play an important role: The willingness of consumers to spend and the willingness of companies to invest depend on expectations about the future economic development. These expectations are formed only partly on facts and partly  influenced by moods.  A paper by Woodford at the meeting of Jackson Hole makes this point: Verbal Commitments by the Canadian central bankers that they guarantee low interest rates, on the condition that the economy does not grow, were more effective than programs such as quantitative easing. Another example of the effect of psychology is the paradox of thrift, which states that efforts to save of  the individual lead to a collapse of aggregate demand. Another example of psychology is described in an article of UBS economist Drew Matus, who describes the reduction in the capital stock in the United States: companies invest too little because they expect a weak future demand.
    
4. My guru in economics, Joseph Stiglitz, writes in an article in Vanity Fair January 2012 about structural change:
   In the 30es, technological progress increased agricultural production (for example through the use of fertilizer) which could feed more people and led to the population explosion. The use of machines in farming required less manpower. The result was a poor rural population, who could not buy anymore products from the manufacturing industry, which in due course also came into diffuculties. Only the preparations for war saved the economy and unemployment declined.
   Today, we have been also experiencing a structural change for 20 years: the globalization of outsourcing the jobs of the industrial mass production shifted to the emerging markets.
   Stiglitz says we must invest in the U.S. in infrastructure, technology and training in order to increase competitiveness. However, he stays silent regarding the ballooning US government debt. Neoliberal economists doubt the effectiveness of these measures. Although, I would like to point out that in all successful Asian emerging markets like Korea, China, Taiwan etc., these kind of economic policy is very pronounced.

As long as the consumer in the United States has not brought his finances into balance, the economy cannot grow sustainably. This takes time. The economy could benefit in the long run from measures to increase competitiveness mentioned by Stiglitz. In the mean time, the US could mitigate the symptoms with monetary policy, fiscal policy, and psychological measures. A way out of the sovereign debt problems is inflation, which could take place in a few years because of the inflated money supply. This will be quite unfavourable for savers, as they will suffer a severe loss of their purchasing power.

Today, the housing market however is recovering slowly. Prices are rising slightly although from a very low level.