Why inflation will not be a risk, just government default.....

The creation of inflation, one of the risks of the explosion of the Federal Reserves balance sheet, isn't really much of a risk these days. In the olden days such as the Wiemar Germany of the 1920's or in more current experiences such as the hyper-inflation in Zimbabwe, where excess monetary creation drove inflation so high that currency became worthless, relies upon the ability to create excess money without people or businesses knowing what is going on.

The problem with the inflationary conspiracy talked about today, is that there is plenty of transparency in the Fed's balance sheet so it would be very very difficult to get a really good inflation going without a commensurate increase in interest rates to compensate. See Bond Vigilantes, here. As inflation expectations increase, so will interest rates to compensate for the loss in purchasing power. So, if inflation rises to 8%, for example, 10-year treasury securities will rise to maybe 10% and one should probably expect 8% T-bills. New mortgages and other financial costs will rise commensurately and this will immediately filter through to damp demand for money and goods across the economy.

So, one may ask, so-what? Well, with demand for money and goods declining, this will lead to lower profits, income and ultimate tax collections. Additionally, the interest on the recently exploding debt, lets say $12 trillion dollars or so in a year, will be an implied approximation of $1 trillion ($12 trillion times 8%). Of course, so that already hold the bonds will lose a lot as the value of the securities decline dramatically.

So, one can expect a massive increase in the cost of funding this debt will drive the Federal Government budget deeper and deeper into deficit. One may postulate that the Government could raise taxes to covered the increased costs but at one point, higher taxes will also dampen economic growth.

So, it appears to me as if the US Government will be forced to restructure their debt, essentially defaulting sometime in the next 10 years. A very real risk.