“The marketplace is suggesting that there's not going to be a lot of inflation in the near term. During the height of the crisis the alternatives to dollar assets were not there. It wasn't irrational, but it was lack of alternatives. What concerns me most about inflation is not something that is imminent. The inflation question becomes more pressing in a 5-10 year time horizon—and it's not 5 years from now, it's 5 years from where the crisis started, which was two years ago. If we had a history of defaults, like in South America, that horizon would be compressed. For other cases, you have more time.”

To underscore the concerns here, I've presented a few charts below on our current fiscal and monetary situation:

Federal tax revenues are still likely to suffer their steepest drop since the Depression

State tax revenues are projected to recover much more slowly than after past downturns.

Total public debt has already soared by 30% since the beginning of the recession, and with unemployment high and initial GDP growth far more tepid than past recoveries (which typically see 6%+ GDP growth out of the gate), is likely to expand further.

Finally, the Federal Reserve has expanded the U.S. monetary base by more than 150% since the beginning of the recession. That is not a typo. The monetary base has soared from $800 billion to over $2 trillion. Much of this has been accomplished through  outrightpurchases of mortgage-backed securities (not repurchases) and an equivalent creation of base money. Unless these securities can be sold back out into private hands for the same value that was paid to acquire them, the Fed will have effectively forced the U.S. government to make its implicit guarantee of these agency securities explicit, without the authorization of Congress. To the extent that the underlying mortgages default, the U.S. government will be forced to issue additional Treasuries to retire the mortgage backed securities now held by the Fed. Alternatively, if the U.S. does not explicitly bail out Fannie Mae and Freddie Mac to the full extent, the Fed will have created money, with no recourse, and without the equivalent backing of assets or securities on its books. In short, the Fed is now engaging in unlegislated, back-door fiscal policy.

To end with a recent quote from Carmen Reinhart, “In America, the Fed has injected a lot of money into the economy as a response to the crisis. Right now the Fed has about a trillion dollars of Fannie and Freddie on their balance sheet, and that's not going to turn out very well, and it hasn't been recognized.”