Washington Panics, Wall Street Soars: Is Runway Inflation Next?

The economy, real estate, and corporate profits are still in the tank, so what’s driving this rally on Wall Street?
Two things:  First, the Fed made a radical decision to buy directly $300 billion in Treasury bonds.  The last time the Fed bought government securities directly was World War II.  Normally, the Fed injects liquidity into the system by buying government bonds from commercial banks, not the Treasury itself.  
But now the Fed gave up any pretence of political independence from the White House and is announcing its willingness (if not preference) to finance Congress’s profligate ways directly.  In short, Mr. Bernanke, who prides himself in appearing to be a stoic Fed chairman, has panicked.  Fearing the worse (another Great Depression), he has thrown caution to the winds to get the economy going, even if it means reigniting another inflationary boom.  
Second, President Obama and his Democrats on Capitol Hill have decided to test the limits of Mr. Bernanke and the Fed by spending money like there was no tomorrow. Damn the market forces of deflation!  
Yesterday the Obama administration announced a bold new plan to buy up bad mortgage loans and other toxic assets on the bank’s balance sheets. That’s on top of the Fed’s decision to buy up to $750 billion in additional mortgage securities on its own balance sheet.  Never mind that the Senate Budget Committee, run by Democrats, just released its report that the federal deficits could approach $9 trillion over the next ten years.  
It is clear from all this artificial interventionism that neither Obama nor Bernanke wants deflation and another Great Depression on their resume.  They are even willing to go down in history as the biggest inflationists in two hundred years to keep us from suffering an economic collapse.  Keynesians and advocates of big government have always preferred inflation over unemployment and economic collapse.   (In my bestselling book The Big Three in Economics, I explain why Keynesian economics is so powerful in today’s world.) 

Wall Street apparently doesn’t care either about the inflationary implications either.  They applauded the decision in Washington with a huge rally on Monday, especially in bank stocks.  
Not surprisingly, most of my gold bug friends are appalled by the radical actions in Washington and are buying more gold.  That’s a pretty smart move, but in the short term, gold actually dropped on the news, and stocks rallied by 6% or more.  
In this month’s issue of my investment newsletter, Forecasts & Strategies (, I anticipated the bottom of the market almost perfectly.  In my front-page story, I told two stories:  the first was about my visit to Princeton University in late 1999 to see Burt Malkiel, author of the famed book A Random Walk Down Wall Street.  We both looked at a chart of the Dow and concluded that the market was grossly overvalued and had to tumble. A few months later, the Nasdaq and the Dow topped out.
Fast forward nearly ten years later:  Last month I was at the Wharton School with Jeremy Siegel, author of the famed book Stocks for the Long Run, and both of us looked at a chart showing that the stock market had reached the trough of its long-term trend line, and every time in the past it has rallied from that low point.  I concluded:  “On an historical basis, stocks are a screaming buy!”  
Certainly the Fed watchers like myself are betting on a rally.  Following the Milton Friedman Rule, the stock market typically recovers 6-9 months after the Fed switches policies.  Six months ago, in early September, the Fed dramatically shifted to an “easy money” policy, and today short-term rates are nearly zero and the money supply (M2) is growing at a 13% clip. 

The trend is clear:  First, we get easy money.  Second, we get a stock market rally.  Third, we get an artificial economic recovery.  Fourth, we get inflation.  Good and hard.  
We are benefiting in the short run with a rally on Wall Street, but in the long run, we are digging a very deep hole of deficits, debt and depreciation of the currency from which we may not escape.