QE3 and Hot Spots

One thing that is not all that well understood, even amongst some libertarians, is that price inflation is not spread evenly, at least in the short term.  In other words, price inflation that takes place because of monetary inflation, is not uniform.  Some prices will rise faster than others.  This should be evident by looking at the previous housing bubble.

I believe it was Richard Maybury who used an analogy of filling a bathtub with thick molasses.  When you pour it in, there will be lumps in the bathtub.  These are the bubbles.  Eventually the bubbles will deflate and spread out.  If you keep pouring the molasses, then there will always be bubble areas that are higher.  The same is true of price inflation.

While I believe the main reason for QE3 was to bail out the banks, there will of course be unintended (or maybe intended) consequences.  There will be price inflation.  However, it will not be uniform.

One thing that drives me nuts is when I (or someone else) am trying to explain why monetary inflation is bad.  I explain that it causes prices to rise.  But some people respond that it doesn’t matter because our wages increase too.

Can anyone seriously believe this now?  It is true that wages will eventually rise, assuming that there is not a decrease in productivity.  But wages lag behind.  Wages in certain industries might rise early on.  For example, wages in construction might rise in a housing bubble.  But average wages tend to be one of the last things that rises with overall inflation.  By the time you get a raise, you will have already been paying higher prices at the store for many months (or more).

So what will QE3 (third round of money creation by the Federal Reserve) bring us?  Where will the higher prices show up?  It is important to remember that it is not just basic consumer goods.  Asset prices can and will go up too.

Not surprisingly, the stock market has been up since Bernanke and the FOMC announced QE3.  Gold has been up too.  Oil was up and has since been on a roller coaster ride.

It is impossible to know where the next hot spots will be as a result of this new round of money creation.  It is easy to say hard assets, but almost everything is a hard asset.  Even stock shares are claims of ownership to a company, most of which have hard assets.  Paintings are hard assets.  Water is a hard asset.

While it is impossible to know how millions of people will react with their money and their actions, we can take a few guesses as to where this new money will flow first.  Since the Fed is buying mortgage debt, it is likely we will continue to see mortgage rates drop, or at least hold low.  So even with the excess inventory remaining from the popped housing bubble, it would not surprise me to see housing prices go up.  I doubt we will see another massive bubble because a lot of Americans are still suffering from the pain of the recent housing collapse.  But I wouldn’t be surprised to see housing prices go up while the mortgage rates stay low.

Not surprisingly, I also see precious metals continuing to do well in this environment.  Gold and silver are classic inflation hedges.  People buy them as a bet against the dollar.  I expect to see new highs in gold and silver in the fairly near future.

If you are looking for an investment with a higher risk/ reward, then gold mining stocks may be the place to look.  Mining stocks have taken a huge beating in the last year, even with the metal price holding fairly steady.  If we see a bubble in gold and silver, we are really going to see a bubble in mining stocks.  Most of these are highly leveraged and there is a potential for huge profits.  By the same token, don’t get caught with these things if and when the bubble ever bursts.  Like any investment with a potential for huge rewards, you should also expect high volatility.

In conclusion, QE3 will lead to more malinvestment and more bubble activity.  It is important to look for potential signals of what could be the next bubble.  While QE3 will make most people poorer, there will be some opportunity for large gains.

2 thoughts on “QE3 and Hot Spots”

  1. Another coin show update, Geoff. I live in Grand Rapids, MI. My bullion dealer had plenty of silver, but very little gold bullion. He said the physical gold market was pretty tight as far as bullion was concerned. He did have about 25 double eagles – mostly St. Gaudens. However, the slabbed MS 64’s were $2025. This is about $250 more than I was paying 6 months ago. So, I bought two rolls of generic 1 oz rounds of silver (40 total). I just felt this was a better play than the double eagles with the ratio being 52 to 1. Thanks for the blog, dude. I read it every day.

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