Money

Ambrose Evans-Pritchard has been blogging with ferocity lately. Common sense dictates that the dollar is facing a huge decline, and many important actors are positioned for such an eventuality.

One would think that the Federal Reserve would be listening to this and tightening up QE and interest rates.

But you have to think bigger before blaming the Fed. Assess these facts:
1. The finance industry is profitable only because of low interest rate borrowing.
2. The finance industry is stabilized because of phony accounting standards, meaning we won't know the true extent of loan losses for at least 2 more years.
3. The finance industry is buoyed by Agency and Treasury debt, much of which is being bought by the Fed. The Fed's purchase of these securities allows FNM and FRE to buy more mortgages and convert them to taxpayer-backed securities, which creates some fine collateral (currently trading at more than par -- if you can believe that).
4. The price of oil will determine the speed of economic recovery.

How do these facts fit together? It means two things. The Fed has to continue QE to keep the finance industry afloat until the loan losses from the subprime/Alt A fiasco can be realized. This means there has to be a justification for continued money printing, which can only come from a perceived deflationary threat. It also means that the dollar has to continue to remain strong in order to keep oil down. QE and strong dollar don't match, you might say. And you're right -- but only over the long term.

Expect this: continued talk of deflation, continued Fed purchases of T-Bills and Agency MBS, and lot's of propaganda about increased supply of oil and larger than expected oil inventories. We will see inflation, and it will be painful, but it will not come for at least two years.