Firstly, it has already been priced in, so even if they do raise it, there could be a “what next reaction”.

If they do not raise rates…….. the dollar will almost certainly rally

Failing the Sniff Test
Now it seems Bill Gross may have joined the same camp, though for some slightly different reasons. In his Investment Outlook article published yesterday, headlined, “Skunked,” he details the staggering size of the financial burden of our unfunded liabilities. As he points out, this is 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. As he points out, 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 about ten times higher than the current level of $250 billion.

The bottom line is he feels 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-$12 trillion counting agency debt), we are “out-Greeking the Greeks.”

He sums up by saying, “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.”

Those, of course, 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, since 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 that is a sign that inflation is likely to begin accelerating.

Of course, inflation is impacted by expectations. If people think prices are going to climb, they buy in advance, and vice versa. Thus, psychology plays a large role. However, as I pointed out not too long ago, the mindset is changing and the genie is out of the bottle.