Help me out here. I know that bank reserves have gone from $40 billion to $800 billion from September 2008 to December 2008 due the Fed’s generosity in creating new money, but those newly created dollars are just sitting there.
I also know that the effects of inflation and additional inflation (money multiplier) will only take place if that newly created money is borrowed, i.e., debt.
It seems that Americans are tapped out with debt and cannot take on anymore, which would indicate that deflation will continue because the newly created debt won’t be borrowed.
Thus, is hyperinflation possible at this point? Wouldn’t it require massive amounts of new debt? Can we take on any more debt than we have?
inflation could happen in an economy with zero borrowing; it just requires the money supply to rise faster than the rate of production of goods. borrowing in fractional reserve economics amplify the inflationary effect of an increasing money supply, but even without amplification it can happen.
My understanding is that loans are only one way to get money into circulation. The Fed could also monetarize the country’s outstanding debt as well. And that’s up to what, $10 trillion? Also, things like the stimulus bill could be paid for directly with new money, taking the debt issuing completely out of the equation.
Is there a method for doing so in the U.S.? I believe our entire system is based on monetizing debt. There is no money unless it is borrowed. Thus the original question. Are we tapped out? Are we at the end of our ropes in taking on more debt? If so, then deflation, not inflation would result. Right?
reid, it doesnt require borrowing. If i sell you some useless junk and you give me millions of fiat money for me to spend on real goods out there; then your the fed and i’ve been quantatively eased. and no borrowing
I ask because many Austrians say that we are experiencing deflation because of the forced liquidation that has resulted from the bursting of the inflationary bubble of the Greenspan era. I agree. Austrians also say that we will experience massive inflation due to the Fed’s policies in dealing with this “credit crisis.” What I have not heard them explain is how the inflation will take place, because people must increase their debt load in order to get the currency running through the system and put the money multiplier effect into play.
So, again, does anyone know?
The seeds of hyperinflation have definitely been planted, but I’m just wondering how they will sprout.
The federal debt was monetized upon issuance, so I don’t know what you mean by this. They can’t re-monetize it.
The fed issues debt to pay for the stimulus and that debt is monetized by the Fed upon redemption. I suppose the Fed theoretically could just print the money without the federal government issuing corresponding debt, but that isn’t what happens. Debt has to be issued.
reid, the bank’s reserves do not have to be loaned out to enter circulation. if the banks experience losses on prior loans, they can use the reserves to pay off their liabilities. In fact, that’s probably exactly why they’re holding them. They are waiting to see the government’s plan to buy up their bad debt. If it keeps them solvent, you bet your ass those reserves will be loaned out at even lower interest rates. If they have to take hits on their assets, then they can use their excess reserves to cover liabilities.
The Fed recently announced it may plan to buy long-term treasury debt. While consumers may not desire taking on debt, the government seems desperate to fill the gap. Look at the Fed’s balance sheet. They are taking on government agency debt in addition to the treasury bonds.
Also, read Bernanke’s paper about inflating the money supply at the “zero-bound”:
Circulation is the wrong term. Obviously the moment the Fed created the new money and credited the banks’ accounts to increase their reserves that put the money in circulation. I should have said that the reserves have to be lent out in order to further the inflationary cycle.
I understand that, but that does not continue the inflationary effect. That takes money out of the system. The only way the money can be multiplied 10 times and increase the money supply further is by lending it.
You’re right, but absent the consumer component, I don’t see how the money supply can multiply as rapidly as it did from 01-07. In fact, consumer liquidation is deflationary, so more than the government has to be borrowing.
I guess several things could happen that would pan out to be extremely inflationary:
The government can guarantee or buy the banks’ toxic assets, which would make the banks loan again. People will borrow once the interest rates are low enough. I’m not sure this can actually happen. The banks toxic assets are probably far larger than the government can afford without destroying the dollar overnight. Just getting the worst ones off the balance sheet, however, will get things moving.
The government can nationalize banking and credit. Expect them to start pulling levers without any understanding of the consequences. Not necessarily hyperinflationary, but maybe…definitely bad.
The banks can finally go bankrupt, and the bad debt can get wiped out. Depositors will have their FDIC insurance paid by the printing presses. When new banks emerge clean from this garbage, loaning and borrowing will forge onward, only with a larger supply of possible “reserves”. If reserve requirements aren’t adjusted upwards, there is extreme inflationary pressure. The FED would be limited in its ability to sell its assets to reduce money in circulation, as about half its balance sheet would be defaulted on by the failing banks. It would have to sell off its treasuries and gold, which it may be reluctant to do.
The FED can start purchasing assets directly to “reflate”. While this is strictly narrow money, the FED seems to have no fear of having narrow money approach broad money in total amounts. This reduces the real interest due on loans, and borrowing will increase. The more borrowing increases, the more price inflation there is, and so on, until real interest rates finally rise. This is a good recipe for an asset bubble. Maybe we’ll get 3 in a single decade…
I am thinking a combination of 1, 3, and 4 will happen, but things will move slowly for the next 1-3 years.