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Inflation And The Dollar Liquidity Trap

Stock Market

In 1960, economist Robert Triffin presented the US Dollar dilemma to Congress exposing a fundamental flaw in the US Dollar system. The U.S. is required to run a budget deficit in order to fuel growth in the world. Over time however, this system creates uncontrollable inflation leading to an erosion of confidence in the U.S. Dollar and its perceived value. If the U.S does not run a budget deficit, the shortage of liquidity in the global markets will lead the world economy into a contractionary spiral.

The Cares Act provided provisions to backstop all types of asset purchases by the Federal Reserve by an Act of Congress, putting in trillion of dollars into the market. Up to $1.1 trillion dollars of that money is still unspent. Treasury Secretary of the U.S. Janet Yellen intends to put that money to work. The sheer volume of liquidity provided by the $1.1 trillion in reserve is expected to be put into the market over the next four months. U.S. asset prices especially its equity market is expected to go higher with some analyst estimating that SPY, and index of the S&P 500 stocks, reaching a high of $420 by mid year.

As banks tighten lending standards, it is exposing an issue with the underlying U.S. economy. The jobless rate last week reported by the U.S Bereau of Labor shows that unemployment claims increased by almost 20%. Small business hit by the pandemic are not recovering  as quickly as expected as bad weather is hampering vaccination efforts by the government.

In the market, investors are loading up on margins as banks are preferring to lend to Wall Street and not Main Street. The amount of margins in the market is showing signs of frothiness and could lead to a severe downturn if an unexpected event happens. This is the liquidity trap. Investors confidence that money, not actually being used to generate productive activity, sitting on the sidelines is bound to cause asset prices to move higher.