Mish finally defended himself against Bob Murphy’s last article here. What is your personal opinion?
For those unfamiliar, Mish has mostly argued that we will have Japan-style credit deflation for some time, and the Fed and government cannot prevent this (without knowingly wreaking havoc on the economy, which they do not want to do). In contrast, several Mises Institute members have said the Fed is dangerously close to hyperinflation…even if it can stave it off from the immediate future, it has no exit strategy on how to eventually avoid such.
My take - Mish is more or less right. The Fed’s ballooning balance sheet is definitely not a purposeful effort to dump money on the ground. It, in conjunction with the interest paid on excess reserves, is an attempt to help raise (steal?) capital for the banks. There are still significant losses ahead that the banks cannot avoid or dump on the taxpayer. In addition, some banks appear to be profiting well from these deals (I assume they are brokering securities and other junk to the Fed, not just simply dumping their existing balance sheets). Central banking has generally operated as Mish indicates - it is able to bail out banks after they’ve made foolhardy loans, but it cannot induce banks to loan without resorting to radical measures such as taxing money/reserves which may induce new crises before even creating a temporary boom.
Also, banks don’t want to loan in a low interest rate environment, especially when everyone already has too much debt that is becoming close to impossible to service. The opportunity cost of sitting on cash is lessened for the banks. This would change in a high-price-inflation environment as interest rates must move up to retain their “real” rate. It seems for interest rates, their nominal value is more important than the real. Yet,
One may counter that real and nominal interest rates were low during the housing bubble. Correct, yet banks felt safe to loan because the value on the collateral was rising. Defaults might be profitable. Also, investors were buying housing securities based upon poor evaluation of risks, allowing banks to somewhat disregard risks as well (if they want mud pies…). Today, on the other hand, there is no credit-driven bubble and a lot of uncertainty. There are forthcoming regulatory changes and taxes on the way. Banks need to evaluate not only the long-term profitability of their borrowers in terms of the market, but political considerations. Take for example, an otherwise sweet deal to open a new coal mine. The bank might want to wait on that.
On the other hand, the Fed can overshoot its target. The banks might fool it into buying too many MBS’s. The government might borrow too much from the Fed. Foreign nations might start dumping the dollar. The banking sector could be further nationalized. A lot of things can happen to push us towards more inflation.
