The Treasury and the Fed have been pumping money into the banks like crazy for the past several months. Everyone knows that. It's called, "monetizing the debt," meaning the governments debt obligations are so high to institutions or nations, such as China, who have bought our Treasury instruments, that the only way we can pay the debt off is literally to print more dollars. Also, the only way to get new dollars into the system, via the various bailout and "stimulus" bills that have become law, is to make, well, new dollars. After all, the government is busted, too - it hasn't had a trillion-plus dollars just lying around, waiting for an economic crisis. Where could the "stimulus" and bailout dollars comes from if not from the Treasury's printing presses? So print they must (see endnote). 
This chart shows the increase in the money supply since 1910. Note that even during the ultra-Keynesian years of the Great Depression, the money supply increased relatively little compared to the last 40 years.
Yet even with the piking of money supply in the last year, and most of that in the last several months, inflation - a steady and significant rise in consumer prices - has hardly registered. Why?
The short answer is that the hundreds of billions of dollars the Fed has been pumping into US banks have stayed there. (The long answer, whence I've derived much of what follows, is here.)
Banks' excess deposits have risen several hundredfold. "Excess" means the amount of money banks retain that is more that they are required to hold. Until last September, banks held in excess (and in aggregate) only about $2 billion. Within only two months they held more than $600 billion. So the Fed's been shoveling them money, but they've held on to it.
This is not because bankers are greedy, quite the opposite. Money in a vault is pretty much worthless to a banker. A bank's assets, the "plus" side of its balance sheet, are its loans. Loans represent the profit centers of banks. No loans means no income, no revenue, no profits. For the banks to hoard those hundred of billions of dollars means they cut their profits, not raise them. Why do that? Because they are unwilling to lend money to bad borrowers, which would mean they would lose both the principal and the interest, leaving them in even worse shape than not lending at all.
Because the banks are not making loans at near the pace or amounts they were even a year ago, the money the government is throwing out the door is staying locked up. It's not making it into circulation. And that's why inflation hasn't occurred. Unless the increased money supply gets into the hands of the people - meaning the banks write it out the door as loans - it doesn't matter how much more money is printed. There's no upward pressure on prices and concomitantly no money to pay for it even if there was.
Instead, we have deflation:
How long will deflation last? Eventually, the dam must burst and the money supply will flood from the banks into the general economy. If production of goods and services is outpaced by the money supply, as it almost certainly will, then inflation will return. Considering how much money is in the reservoir, inflation will probably return with a vengeance.
Ah, but timing is everything. When will the economy turn around? First, businesses have to think of their future in rosy enough terms to take on debt again. Then, they have to demonstrate to banks that they are worth lending to. Banks have to be sound enough themselves to be worth borrowing from and must start writing the loans. How close are we to the beginnings of that process?
EricTyson.com explains the meaning of this graph:
Watson Wyatt is one of the world's largest benefit consulting firms so they work with many employers. They regularly survey companies for their future hiring and firing plans. Their just released February survey offers some optimism that the heavy layoffs may soon be ending:Of course, things can still go downhill faster than this research predicts. And by no means does this graph indicate that a new day is about to dawn. But there is also reason to believe that Ben Bernanke could be right: the recession may have ended, at least just barely so, by the end of this year. Maybe, maybe not, but whenever the turnaround comes, true inflation won't be far behind.
"A new update to an ongoing series of surveys conducted by Watson Wyatt, a leading global consulting firm, shows that most companies have already made most of their intended sweeping changes. However, many expect to make further cost-cutting changes this year, such as salary and hiring freezes, and reduced 401(k) matching contributions."
"According to the survey of 245 large U.S. employers conducted last week, 52 percent have made layoffs, up from 39 percent two months ago. However, the number of companies planning layoffs has fallen 10 percentage points from 23 percent to 13 percent. Additionally, 56 percent now have a hiring freeze in effect, an increase from 47 percent in December’s survey."
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3 comments:
Overall a good post but I have a few quibbles:
1. We are not financing the stimulus and bailouts (or at least the non-Fed ones) by 'printing money'. We are financing them by borrowing and given that big money (banks, pension funds, mutual funds etc.) are too timid to put their money anywhere else they are happy to loan it to the US gov't at super low interest rates.
2. Long term rates are low as well as short term rates. This is in indication that the market is not betting on massive inflation in the future, that is indeed interesting considering how much money supply creation has been going on.
3. You forget that the Fed can destroy money supply just as rapidly as it can create it. In the early 1980's it jacked short term rates into the double digits. Should banks unleash that flood of hoarded money into the economy as spending it can be countered before it turns into hyperinflation.
4. Inflation would almost certainly boost real estate prices (it's very hard to see how home prices can fall if inflation picks up and goes to, say 10%). Real estate going up means a lot of those 'toxic assets' become green....green meaning profitable. That alone would lower the Federal Deficit as TARP money gets repaid and the commonstock taxpayers now have in AIG, Citi etc. becomes valuable.
I think what has happened is best described as a balance sheet depression. We (meaning the economy) suddenly became fearful of our debt balances. This fear was no doubt set off by the collapse of 'respectable' firms like AIG, Bear Sterns, Citi and so on....as well as a general sense that "we've had it too good too long, it's time to pay the piper". As everyone tries to lower their debts, improve their cash position and so on spending collapses. Gov't needs to step in to maintain total spending or else income will collapse too creating a situation where even though everyone is trying to be responsible (by paying down debt, improving their balance sheets) no one can (you can't save what you don't earn....aka the paradox of thrift).
What is happening, then, is that the gov't is letting it's balance sheet get worse while everyone else works to improve their personal balance sheet. You can almost say the gov't is asorbing our 'sins'. IMO it there's a number of ways it could do this. I'd rather see this 'balance sheet transfer' be broad based. Hence, IMO, I think the stimulus package is not so bad. Let the 'improved balance sheets' filter down to diverse states, agencies, individual workers, and so on. While it may seem cleaner to just give citi, AIG, and BoA $350B each of Fed created money, I don't think it is as good in the long run. If you help 'everyone else''s balance sheet rather than doing a massive balance sheet infusion for the Big Players you allow the market to recover AND for the banks in deep trouble to fail without hurting too many other people. If you put all the bailout to the big players you may fix the problem now but you're just setting up the next round of 'too big to fail' headlines 10, 15 or 20 years from now.
Thanks for your excellent observations. I would quibble in turn with only the assertion that we are not financing the bailouts by printing money, but with borrowed money. The debt, meaning the Treasury notes, is itself paid for with cash money, that being the only way the T-securities are paid off. That means we either print it now to pay off notes now coming due, or we print it later when today's issues come due. In fact, we're doing both.
But even if we're receiving hundreds of billions from China, the Saudis or even Russia (aggregately), it still doesn't change the fact that the domestic money supply in increasing without a corresponding increase in circulation. The money has just swapped holding pens from Chinese vaults to American vaults (whether physical or electronic vaults doesn't much matter).
As for inflation and real property prices, you are exactly right: real property is one of the best investments to protect one's wealth against inflation.
My own fear is not that we will get some inflation, which I would prefer to call appreciation (as in appreciation of assets), but that, in order of greater to lesser fear, we'll get high inflation without employment and productivity keeping pace (hello misery index) or that we'll get double-digit inflation and earning power won't be able to keep up.
"The debt, meaning the Treasury notes, is itself paid for with cash money, that being the only way the T-securities are paid off. That means we either print it now to pay off notes now coming due, or we print it later when today's issues come due. In fact, we're doing both. "
Or we simply reborrow what we owe now leaving the balance there but only paying the interest with tax revenues a bit like the Home Depot card you keep a constant balance on.
"it still doesn't change the fact that the domestic money supply in increasing without a corresponding increase in circulation. The money has just swapped holding pens from Chinese vaults to American vaults (whether physical or electronic vaults doesn't much matter)."
I suspect circulation has gone down. The classic monetary equation is MV = PT....roughly Money times Velocity equals Price times Things. If M goes up then P or T (real production) must go up. But what if V has gone down? Then you may need a massive money supply increase just to hold off deflation. If people are spooked and as a result hold onto their dollars more tightly (and businesses too), then we might be in a period of reduced Velocity over the long run which means you may have a massive Money supply increase and will never see inflation result from it.
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