DowJones,risingyieldsandFed'sBullard

Dow Jones hit an all-time high yesterday to close at 31522. Hang Seng is also trading near its 3-year peak. The US treasury yields are also rising with the 10-year rising above 1.3% for the first time in a year. The yield curve has also steepened with the gap between 2-year and 10-year trading close to 115 bps. The rising yields indicate that the markets are expecting the inflation to return with a 1.9 trillion USD stimulus and a comprehensive universal vaccine rollout both becoming reality in the coming days. In a television appearance the St Louis Fed President James Bullard said that he doesn’t see bubble in the asset prices and doesn’t see a need to start the tightening the policy anytime soon. He also added that the Fed is keeping a close watch on inflation to ensure that it doesn’t get out of control.

Our readers would identify that inflation is one topic which we keep coming back to. Inflation or the lack of it can ultimately manifest because of two reasons. Firstly, there can be some kind of demand supply shock and secondly it can be due to the easy money policies of governments and central banks. Now the second point about the untethered fiat money creation take us to an even deeper discussion about the concept of money itself. The money in its most basic form serves three purposes, firstly as a medium of exchange, then as a store of value and finally as a unit of account. The medium of exchange removes the problems associated with the barter system as people don’t need to search for parties which have an exactly opposite and commensurate need as themselves. But medium of exchange would only work if the second point about the “store of value” is intact.

Author James Rickards in his book The Currency Wars writes about the post WW I Germany where funding the war reparations bill prompted the German Central Bank to print so many Deutsche Marks that it effectively became worthless. He writes that as the money flooded the system, the people rushed to swap their cash or cash like assets for goods thereby aggravating inflation. And finally, high inflation entailed a complete breakdown of public confidence in the role of fiat money both as a store of value and a means of transaction. At such breakdown levels we saw hyperinflation (infinite inflation) as the denominator that is the value of money reached zero.  

In the current scenario where the Dollar is the reserve currency of the world, such a scenario of widespread distrust seems distant, but we are seeing the alternative options getting limelight. In the case of unregulated digital money, the fact that they are gaining acceptance as a medium of exchange (more people accepting it) and as a potential store of value (courtesy expected inflation in fiat money) is adding to their allure.