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Related topics: spending, financial crisis, Federal Reserve, Ben Bernanke, Bill Fleckenstein

Regular readers know where I stand on the subject of the Federal Reserve's monetary policy. Namely, I believe that the consequences of its quantitative easing programs (the second of which is scheduled to end in June) will be currency debasement and rather high rates of inflation.

Now it seems Pimco's Bill Gross may have joined the same camp, although through different reasoning from mine.

The $75 trillion puzzle

In his Investment Outlook article published earlier this month, headlined "Skunked," he details the staggering size of the financial burden of our unfunded liabilities.

As he points out, these liabilities are not some theoretical estimate of future spending, but rather "the discounted net present value of current spending, should it continue at the projected demographic rate." The sum total is around $75 trillion.

Image: Bill Fleckenstein

Bill Fleckenstein

As Gross illustrates, if you use the CPI plus 1% to calculate the interest rate on the debt (which is the rate he used to discount back the government's future liabilities), interest expenses would equal $2.6 trillion, which is more than 10 times higher than the current level of $250 billion.

The bottom line: He feels that the size of unfunded liabilities (a consequence mainly of entitlements) means we are headed to an increased use of the printing press. Gross suggests that, when it comes to the size of our real off-balance debt, as opposed to the size of the $9.1 trillion on-balance-sheet national debt ($11 trillion-$12 trillion counting agency debt), we are "out-Greeking the Greeks."

He sums up by saying that "the only way out of the dilemma, absent very large entitlement cuts, is to default in one (or a combination) of four ways: 1) outright via contractual abrogation -- surely unthinkable; 2) surreptitiously via accelerating and unexpectedly higher inflation -- likely but not significant in its impact; 3) deceptively via a declining dollar -- currently taking place right in front of our noses; and 4) stealthily via policy rates and Treasury yields far below historical levels -- paying savers less on their money and hoping they won't complain."

No one's default but our own

And finally, "Unless entitlements are substantially reformed, I am confident that this country will default on its debt; not in conventional ways, but by picking the pocket of savers via a combination of less observable, yet historically verifiable policies -- inflation, currency devaluation and low to negative real interest rates."

In fact, those are exactly the policies we are pursuing now, which is why we are where we are. Inflation has become the order of the day, and it will only intensify. Exactly when I can't say, but it is worth pointing out that after "QE" began, for about eighteen months, the monetary base did not really percolate. But so far in 2011 it has exploded by 20% or so. I think this is a sign that inflation is likely to begin accelerating.

Of course, inflation is affected by expectations. If people think prices are going to climb, they buy in advance, and that in turn can help push up prices. Thus, psychology plays a large role. However, as I pointed out last February in "No such thing as good inflation," the mindset is changing and the genie may be out of the bottle.

Corporations may think they can keep prices the same and shrink the contents of their packages to make people believe nothing has changed. But when the New York Times runs an article about that practice on its front page, as occurred a couple of weeks ago, you can be pretty sure people get the joke, and behavior patterns will start to change.

So if inflation were a stock, I would certainly buy it aggressively, and I would buy long-dated calls on it, too.

Hear Bernanke see no inflation

And what do the great stewards of the common good at the Fed have to say? While I make an effort to filter out their blathering (because all that matters is what they're going to do, which we already know), I did note what Fed Chairman Ben Bernanke said in his April 4 speech. He reiterated his view that inflation is not going to be a problem: "The increase in inflation will be transitory. . . . Our expectation at this point is that in the medium term, inflation, if anything, will be a bit low. We will monitor inflation and inflation expectations very carefully."

The reason this is important to note is because I think he is telling us what he actually believes, and I can almost guarantee that the Fed will be way behind the curve when it comes to fighting inflation, for three reasons.

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First of all, inflation statistics understate inflation. Second, Bernanke has faith in his own ability to stop it virtually at will (as he once stated in a "60 Minutes" interview), though I think he is secretly not even sure inflation can get started. Third, Bernanke has been so certain that he must battle a deflation bogeyman that doesn't exist that he was always bound to be slow in responding to inflationary pressures. What we can expect from the Fed is a whole lot of speeches and chatter about expectations, but action will be tiny, timid and way too late.

It amazes me that people pay so much attention to what any of these Fed heads have to say. We all know where their biases lie, and the fact that markets flinch every time one of them talks tough is almost comical. Recall that it was a little over a year ago when so many were worried about ending QE1 and the withdrawal of liquidity, and what we got instead was QE2.

In any case, it is what it is, and people will focus on what they will.

You won't feel a thing

It is a shame that people like Malcolm Bryan, a former president of the Atlanta Fed, aren't still around. As quoted from a 1957 speech in the latest issue of Grant's Interest Rate Observer, he described the net effect of "premeditated inflation" (his term for a little bit of Fed-induced inflation) on the average money-saving citizen as follows: "Hold still, little fish. All we intend to do is gut you."

This column is a synopsis of Bill Fleckenstein's daily column on his website, FleckensteinCapital.com, which he's been writing on the Internet since 1996. Click here to find Fleckenstein's most recent articles.