Posted on 11/04/2009 10:35:37 AM PST by blam
Four Reasons Hyperinflation Hasn’t Hit The US... Yet
Keith Fitz-Gerald
Nov 04, 2009 11:30 am
This uncertain limbo isn't good now, or ever.
Everything we know about classic economic theory suggests the US economy should be experiencing Zimbabwe-like hyperinflation right now, thanks to the nearly $2.2 trillion the US Federal Reserve has pumped into the system.
But we’re not... yet.
Classic economic theory says that money supply can be used to stimulate the economy and our central bankers seem to agree. That’s why they’ve pumped more than $1 trillion dollars into the economy, engineered countless bailout bonanzas for zombie institutions, put Detroit on life support, and delivered a bunch of financial Band-Aids to the trauma ward -- all in a desperate bid to make Americans feel better about the global financial crisis.
To their way of thinking, the trillions of dollars have been a success. That’s why any meeting of the Group of Eight nations looks more like a mutual affection society with central bankers eager to claim credit and backslap each other in congratulations for having avoided the “Great Depression II.”
But by taking the Federal balance sheet to more than $2 trillion from $928 billion 2008, they’ve created a situation that should have resulted in an epic inflationary spike to accompany the 137% increase in liabilities.
[snip]
(Excerpt) Read more at minyanville.com ...
In the United States, the printed dollar is a tiny percentage of the total "money" in existence. Most of it is created by the fractional reserve banking system. When banks shut off the funding spigot to borrowers, the amount of money in the economy began to collapse. If Congress hadn't printed dollars in that moment (back when Lehman Brothers failed), we would have gone into crippling deflation where a guy who had a $100,000 house would see the value of it fall to $70,000 but his mortgage remain the same, effectively putting him further into debt.
The danger is that Congress will continue to run deficits (the current project is $9.5+ trillion over the coming 10 years). If that happens, the total printed money will exceed the M2 and M3 money levels by far, causing severe inflation. We are not yet to that point, but we can see it on the horizon.
Now, even if the inflation were terrible, it wouldn't be anywhere near what post-war Germany or Zimbabwe experienced because the money is always compared to the overall size of the economy. Our debt as a percentage of GDP would only then be approaching that of Japan. That's a lot of inflation to get there, but still not unprecedented for a G7 country.
I don't have faith in Congress to stop spending money so I think inflation is inevitable. But it's important to understand why we're not there yet to avoid drawing false conclusions.
bookmark
Good post. Thanks.
There is no inflation, hyper or otherwise, because money demand spiked on the market crash. Men now voluntarily hold 15% of their wealth in savings forms, down from 10% at the market peak.
There is also no inflation because there is nothing magical about money among assets, and in the period when money held by US households increased $1 trillion, the value of all assets owned by US households fell $11 trillion.
Money is not wealth. Declining nominal wealth values are very far from inflationary.
Great article, blam! Thanks for posting it.
You're correct that money is not wealth. Your presumptions would have been correct if - and this is where it falls apart in the real world - we were dealing with a debt-free population.
That's simply not the case: A vast majority of Americans have debt on their home and their car. When the debt level is fixed in nominal terms (in this case something we call the U.S. dollar), and the asset value falls in nominal terms, the person has lost real wealth because they now have to pay back nominal debt with harder to acquire nominal currency. By artificially drowning the banking system in replacement liquidity as the money multiplier collapsed, this outcome could have been avoided (and it was).
In other words, if you were debt-free and owned a house, changes in the money supply wouldn't influence your real wealth level one penny. The moment you introduce debt, which is quoted in nominal terms, you have created a legal liability with real world court consequences if you fail to satisfy the debt (foreclosure). At that moment, changes in the nominal value of the artificial currency do have a direct, and powerful, influence on your wealth level. A vast majority of Americans have debt. That's where your analysis fails the real world test.
You must learn to separate academic models from real world application. Economics makes a lot of foolish assumptions, such as the "rational buyer. Everyone knows that a woman walks into a store on 5th Avenue and sees a Hermes bag, rational economic calculus is not factoring into her decision about the acquisition of that bag. She is interested in one thing only: Improving her appeal to the opposite sex and status among other women. This means she's likely to pay more than the bag is actually worth for the "label". The analysis you provided makes the same sort of mistake by ignoring the day-to-day reality of the citizen base.
By increasing the total level of Treasury bills in circulation in an absolute sense, it's a backdoor form of inflation and one of the most widely used ones in history. It seemed pointless to detail that process in the post. Most people intuitively understand that it is Congress that has the power, indirectly through its legislative decisions, to increase or decrease the level of inflation, both through the Treasury Department and manipulation of the debt ceiling, and through the Chairman of the Federal Reserve, whom they can install or remove from office, as well as abolish the institution altogether.
Isn't that exactly what happened?
Thank you for your informative post.
bookmark
Yes. We got a bit of it, but nowhere near what it would have been if the Fed hadn’t drown the system in liquidity. If we had just stepped back and done nothing, you would have seen stocks go down to the 1932 and 1933 levels where they traded for less than the value of the *cash* the companies had in the bank, essentially giving the business away for free.
This wouldn’t have been because people didn’t recognize the assets were cheap. It would have resulted from them being unable to raise the money to buy anything because their own wealth had been decimated and no bank would be able or willing to lend.
But by taking the Federal balance sheet to more than $2 trillion from $928 billion 2008, they’ve created a situation that should have resulted in an epic inflationary spike to accompany the 137% increase in liabilities.
WOW
****In the United States, the printed dollar is a tiny percentage of the total “money” in existence. Most of it is created by the fractional reserve banking system. When banks shut off the funding spigot to borrowers, the amount of money in the economy began to collapse. If Congress hadn’t printed dollars in that moment (back when Lehman Brothers failed), we would have gone into crippling deflation****
I have some questions for you then.
1.) Stupid housing loans mandated to the banks(mainly by democrats in congress) were certainly a part of this collapse of the big lenders. How much a part do you attribute to the bad loans?
2.) Am I wrong in not seeing any real changes so far in legislation and oversight?
3.) If I am correct in my assumption in question 2, is this not a new mechanism for control of the economy and also control of power through politics?
4.) What are the necessary steps to avoid the collapse of the lenders again?(your answer to 2 may answer this question).
1.) The mandated loans were a big part but not nearly as big as one, fatal development: The moment community banks failed to hold on to the loans they originated (forcing them to live with their underwriting results), we had a recipe for disaster. If you are lending your own money, you're going to be more careful than if you're lending a stranger's money. It's human nature.
2.) Nope, you are 100% correct. There have been no meaningful regulation changes or new laws to address the problem. In all sincerity, it could happen again 3 years from now unless something is done.
3.) You could be but I think it's more fundamental than that: People always want to make money and if they can do it with the promise that government will bail them out, they're not going to willingly give up that security blanket (just think of a worthless twenty year old who still depends on mom or dad to pay the bills). I think it's a case of individual human nature, not some grand scheme.
4.) The way to solve it is simple and requires two parts:
Part A.) All derivatives must be placed on an exchange, just like stock options, so that bets include a small insurance premium that goes to the exchange itself. If one of the parties goes bankrupt, this insurance fund pays off the counterparty. It's worked for the stock option market for generations and it will work here. When Lehman melted down, or AIG had problems, the exchange would have simply stepped in and handled the problem without the need for Government involvement.
Part B.) Traders at firms need to be personally liable for transactions of their companies. In the old days, Goldman Sachs, Lehman Brothers, and others were pure partnerships, meaning that if one trader put the whole system at risk, every other employee in the building had their home, car, and bank accounts on the line. This caused people to check their coworkers trades and severely limit what they were willing to wager. We have to tie that downside risk back into the compensation arrangements if we want to solve the problem. After all, if you were a partner at Lehman and saw that the guy at the next desk was wagering 30-1 on soybean futures, you may just call a meeting and shut him down because you don't want to find yourself awake at night worrying about the crop report.
Thank you for your quick reply.
In response to your answer of question three. If you are correct that the situation purely developed because of human nature and was not a well thought out plot for control, now that the mechanism is in place and there are no steps(I like yours by the way) to remedy the problem then human nature would dictate that it will be exploited.
“...in the period when money held by US households increased $1 trillion...”
Is that another way of saying newly printed money acquired?
So you are saying Bush did the right thing by creating TARP.
Yep. That’s the problem and our worthless Congress is doing absolutely nothing to solve it. The incentive system hasn’t changed. The average memory of an investor is about 3 years - give it another year or two and most will completely have forgotten about the pain of watching the Dow go to nearly 6,000.
For all of its faults, TARP had some necessary components. If, for instance, the commercial paper guarantee program hadn’t been put in place, the world as we know it would have ended. The problem is, the government has done such an inept job managing its own budget, no one trusted it (rightful so) to intelligently manage a bailout program.
All in all, TARP (not what came afterward, but the initial liquidity that was provided in the days following the Lehman Bros failure) was a necessary evil. Without it, I firmly believe we’d be in Great Depression II right now because corporations would have had no choice but to immediately hoard every penny they got to cover payroll and the financial system would have gone backwards 200 years overnight.
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