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A mere two days before Ben Bernanke announced QE3, I began to situate my own portfolio for an inflationary environment.  I did this after looking at Federal budget deficits and looking at M2 money supply figures.

In the past five decades, M2 has only spiked above 10% maybe six times.  Four of those times, we saw significant CPI inflation.  And I’d argue we saw inflation a fifth time, as well, except that the Bureau of Labor Statistics modified the way they measured inflation in 1982 to eliminate housing prices.  If you re-insert housing prices into CPI, we actually had inflation upwards of 7% and 8% from 2003 – 2005.  So by my own measure, 5 out of 6 times M2 spiked above 10% growth, we saw significant inflation (i.e. inflation above 5%).

The only exception came during the financial crisis during 2009.  We saw a mini-spike in inflation there (by my measure, it briefly topped 4%), but the deflationary pull in the housing market was enough to offset it.  The problem in 2012:  the housing market has already bottomed.  Rental vacancies are at record lows.  A recent study shows that buying is now cheaper than renting in *ALL* of the largest 100 US markets.  I don’t think there’s a “deflationary tug” from the housing market any more.  Rather, the bias is in the opposite direction.

You couple all of this with the President’s reckless spending habits and the Medicare bomb we’re about to see over the next decade, and it’s difficult for me to see a future that does not look an awful lot like the 1970’s.  Even the Paul Ryan plan (that the Democrats have demonized) is not all that aggressive in cutting the deficit.  I will give it credit for addressing the Medicare issue (which is in actuality, the biggest issue our nation faces), but it still keeps military spending sky-high, and does little to address Social Security’s problems.

For those that know me, you know I’ve not been in the “inflation camp” for the past several years.  This is a rather recent switch for me and it’s based on examining a lot of data that shows inflation might be creeping upwards.  Btw, it’s not just M2; if you look at CPI excluding food and energy (supposedly the measure that the Fed prefers), it’s actually been moving upward over the past year or so.  It seems to be at what you might call “normal” levels now.

So to initiate a monetary stimulus right now seems like a terrible decision.  We’re finally seeing signs that the economy is normalizing.  The biggest obstacles to hiring are actually Obamacare and Dodd-Frank.  I don’t think the Fed can create jobs merely by loosening monetary policy.  Instead, what we’re going to see is M2 money supply spiking again, and eventually leading to significant inflation.

Don’t get me wrong:  everyone talking about hyperinflation is being sensationalistic.  But 5% – 7% inflation is not outside the realm of possibility.  And contrary to popular belief at the Fed, I don’t think it will create much in the way of new jobs.  So we’ll get stagflation.

So almost by sheer accident, my “inflationary portfolio” decision two days ago looks brilliant.  While the media was talking about QE3, the media is also pretty stupid when it comes to these things.  I thought the Fed might actually see the same data I’m seeing and say, “hey, maybe we should just leave well enough alone right now.”  The hawks at the Fed had become increasingly forceful in their dissents, so I thought it was unlikely to see more stimulus.  Apparently, I overestimated the strength of the hawks.

As usual, I hope I’m wrong about all of this.  But I already saw hints of inflation before QE3 … now this only further complicates things.  Of course, this could all get reversed based on political decisions in Washington (i.e. the fiscal cliff), but I think there will be some agreement there.

In any case, this might be a very poor time to buy any securities that rely on interest rates not rising over the next few years (e.g. annuities, treasury bonds, etc).  If you want to buy a house, now would be a great time.