This morning the 10 year bond rates broke through the low set in January 2009, touching 3.91%. Predicting the upcoming inflationary surge due to global money printing has been a consistent widow maker for traders over the past few years. Even the best have been caught out, betting against falling rates, including PIMCO, the $1 trillion dollar fund manager. Read here.

Modern Monetary Theory (MMT) has consistently reminded us that borrowing by Government, who issue their own currency, actually puts downward pressure on interest rates. Counter intuitive maybe, but that is actually how it works. The Government spends a $1 million dollars in social security benefits, overdrawing their RBA account. People spend the money or save it in a bank account, but by the end of the day that $1m dollars is a surplus deposit in someone's bank account. That someone could be Woolworths, Harvey Norman, a child care centre, but it must be surplus cash somewhere. The bank or banks in surplus must lend it to someone that night, and the only borrower is the Government who has the mirror borrowing. What happens when there is surplus cash in the system? Rates must go down. The RBA cash rates have nothing to do with money supply. A financial asset always has a corresponding financial liability by definition, the system is always in balance. RBA cash rates are just a self imposed straight jacket that are deemed necessary to achieve mandated policy aims. How many breathless media articles have you read telling you the opposite, that printing money must be inflationary?

The Credit default swaps tell us that to insure Australian Government debt costs 0.88% per annum. That bet is saying that Australia will forget how to print money. The only risk may be the intransigence of a political party not wanting to borrow anymore, as nearly happened in the US recently.

Over the past few decades developing countries have been exporting to Europe and the US, exchanging their goods for foreign currency. When you are an exporter with US dollars you will likely try and sell the US dollars and buy your local currency. Countries like China prefer not to have a strengthening currency, so the Government sells the local currency and buys the US dollars to suppress their exchange rate. Locally the developing country has a booming economy and the Government is printing money, see Developing Nations fight Inflation. It may be an idea to also read one of the many articles about Chinese inflation. There will come a point when developing countries will allow the currencies to reset to a higher level. If China stopped buying US dollars, the Renminbi (RMB - the official currency of China) will appreciate and the US dollar will fall. The US (and Europe and Australia) will have much higher import prices and inflation will result. The danger to the world economy will be this inflexion point - where the US and other countries moves from a monetary easing bias to a tightening bias. This is the real inflation trade and the one to prepare for.

Michael Cornips