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Monday, November 8, 2010

Flushing Savers From Their Foxholes

"Certificates of Confiscation" Once Again?

Certificate of Confiscation: 1970's term for bonds, certificates of deposit (CD's), etc. yielding less than (rising) inflation.

How do you get people (and corporations and banks) to stop hoarding cash, and put it to work, stimulating the economy?

Reduce interest rates to zero.

But what if that still doesn't do the trick?

Make holding cash not only unremunerative, but costly.

The best way to do that is to devalue the currency and/or create inflation, so that the value of cash steadily erodes, precipitating an inexorable stampede into . . . anything else.

Fleeing Cash

Which is basically what has been happening since late August, when The Federal Reserve signalled its intent to further stimulate the economy by printing more money (called "quantitative easing").

Since then, stocks have rallied about 10%, and commodities -- especially gold and oil -- are up anywhere from 15% to 40%.

Meanwhile, the dollar is down 8% against a basket of major currencies.

(Un)Intended Consequences

The problem with driving savers out of their negative-yielding foxholes is, what comes next?

The Fed hopes that all that liquidity will find its way into the stock market, driving up prices and creating a "wealth effect" that will spur spending and the broader economy.

But it's just as plausible that erstwhile savers will switch their affinity to something -- anything -- that promises immunity from central bank debasement.

That list includes: gold, silver, oil, wheat futures, Swiss francs, Australian dollars -- you name it.

As those things appreciate, they create inflation, which punishes consumers, which hurts the economy.

Can you say, "full circle?"

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