Why You Must Immediately Bet on Inflation

Last week, the Fed took its first step in a new, more desperate tactic to fix the financial system...

Up until last week, the Fed's operations since the beginning of the credit crunch had not created any new money supply. It had been swapping troubled assets on bank balance sheets for Treasury bonds. It was taking bad loans off banks' books and giving them good loans instead.

That improves a bank's balance sheet... and strengthens the system. But it creates no additional credit. It's not inflation.

Then, last week, it took a "quantum leap," according to George Goncalves, the chief Treasury and agency strategist at Morgan Stanley.

Instead of swapping assets in the banking system, the Fed started buying them. The Fed bought $5 billion of Freddie Mac, Fannie Mae, and Federal Home Loan Bank corporate debt. The New York Fed's website says the purchases are being "financed through the creation of additional bank reserves." The Fed has finally started to create money out of thin air.

In other words, to pay for its purchases, the Fed opened new bank accounts for its commercial bank customers, struck a couple of computer keys, and filled the accounts with money. The Fed hopes the banks lend this money out. If they do, it will add credit to the marketplace... That's inflation.

The idea behind this new strategy is to help homeowners refinance their debts at lower interest rates. A purchase of $5 billion is a tiny amount for the Fed, but think of it as a test. The Fed wanted to make sure the market wouldn't flip out over this new ultra-inflationary strategy.

The market didn't flip out. And the strategy worked. The average rate on a 30-year fixed-rate mortgage fell from 5.97% to 5.53%... the largest weekly drop in 27 years.

Now that the Fed sees how successful this strategy was, we can expect the government to continue with it. This is great news if you own investments that respond well to inflation, like gold, silver, and other commodities. 

First, the public is 100% sold on the idea of imminent deflation. Commodities and gold are selling at bargain prices. In the markets, it pays to bet on the underdog.

Second, there's no political resistance to inflation. The dollar is in its strongest uptrend this decade, and Treasury rates are at all-time lows. There's no reason for the government not to inflate. There's no economic penalty for running an inflationary policy. Plus, the public is demanding stimulus and bailouts right now. They're giving politicians the green light to create money.

Finally, over $8 trillion is sitting on the sidelines in money market accounts and short-term Treasuries. Meanwhile, some unknown trillions have disappeared from the world's supply of assets in the credit crunch. When the supply of money and credit expand in relation to the supply of goods and services, you get inflation.

The easiest way to bet on inflation is with an exchange-traded fund like GDX. It's an index of the biggest gold-mining stocks. If the stock market rallies at the same time gold rallies – which should happen when inflation hits – GDX will rise like a rocket.

Good investing,

Tom