Close X Cookies are necessary for the proper functioning of 24hGold.com. By continuing your navigation on our website, you are accepting the use of cookies.
To learn more about cookies ...
EnglishFrench
In the same category

On the Brink of Inflationary Disaster

IMG Auteur
Published : August 25th, 2011
1339 words - Reading time : 3 - 5 minutes
( 16 votes, 4.6/5 )
Print article
  Article Comments Comment this article Rating All Articles  
0
Send
0
comment
Our Newsletter...
Category : Fundamental

 

 

 

 

Ever since Ben Bernanke began his massive infusions of money into the financial system, many analysts (including me) have been worried about the severe weakening of the dollar if and when the fractional-reserve-banking system magnified the initial injections severalfold.

Although the trend could reverse, data from the past two months suggest that the inflationary big one may be upon us.


Keeping the Genie in the Bottle

To understand the potential problem, we need to review some basic facts. Back in the fall of 2008, when Lehman collapsed and the entire financial system appeared in jeopardy, the Fed began bailing out investment banks through massive asset purchases and extraordinary lending operations. These activities rescued the major banks that would otherwise have gone bankrupt, by taking bad assets off their books (at inflated prices) and by propping up the new "market" price of the assets remaining on their books.

When the Fed buys an asset, it writes a check on itself. This action creates new electronic reserves in the banking system. For example, if the Fed buys $10 million in mortgage-backed securities from Joe Smith, then Smith will deposit the check in his own checking account. His bank will credit Joe Smith's checking balance by $10 million, but at the same time the bank's account with the Fed itself will rise by $10 million too.

At any time, regulations insist that commercial banks in the United States keep a minimum amount of reserves set aside in order to "back up" the demand deposits (think of checking accounts) of their customers. For example, if a commercial bank's customers think they have a total of $1 billion in their checking accounts, then the Fed's regulations force the commercial bank to keep (roughly) $100 million set aside in reserves. These reserves can consist of green pieces of paper stored in the commercial bank's vaults, or the reserves can be electronic entries showing how much the bank itself has on deposit with the Federal Reserve.

The following chart shows how much in new reserves the Bernanke Fed has pumped into the system in the last three years:


24hGold - On the Brink of Infl...


Notice that "excess reserves" are historically very close to zero. This reflects the tendency (assumed in textbook discussions of "open market operations") for commercial banks to quickly lend out any reserves they have, over and above their legally required minimum. Yet as the chart above clearly indicates, since the onset of the present crisis the commercial banks have not been making new loans. Instead, they have allowed the huge injections of new reserves to sit parked at the Fed.

There are several (possibly overlapping) explanations for this break from the past. Keynesians such as Paul Krugman argue that this was the predictable outcome during a liquidity trap. Proponents of MMT (modern monetary theory) argue that the economic textbook discussions have things upside down, and that banks are never constrained by reserves when deciding on making new loans. Quasi monetarists lament the Federal Reserve's decision in October 2008 to start paying interest on excess reserves — a policy whereby the Fed actually bribes banks not to make loans to their customers. Free-market guys like Mish (as well as some card-carrying Austrians) have argued all along that significant price inflation was never on the table, so long as the financial system worked through a painful process of deleveraging.

Regardless of their specific explanations for why commercial banks hadn't been lending out the trillion-plus in new reserves Bernanke created, just about every pundit agreed that this fact was a major reason that what seemed to be incredibly inflationary policies weren't leading to skyrocketing prices.

However, if the trend of the last months continues, that period of containment appears to be over. All of those pundits who hedged their predictions by saying, "So long as those reserves stay bottled up at the Fed …" may need to go back to the drawing board. Recent releases from the Fed show that the excess reserves are starting to leak out.[1]


The Fed's Latest Figures on Reserves

Here are the relevant figures from the Fed's latest (August 18) H.3 release:

Reserves of Depository Institutions (millions $)

Two weeks ending …

Required

Excess

Jun 15, 2011

$76,601

$1,609,786

Jun 29, 2011

$78,682

$1,567,444

Jul 13, 2011

$77,024

$1,634,382

Jul 27, 2011

$77,968

$1,607,797

Aug 10, 2011

$81,303

$1,601,997

The above data are consistent with the commercial banks finally beginning to lend out their excess reserves — something that they typically do, but (for various possible reasons) have not done during the current crisis.

To double-check our conclusions, we can show that demand deposits at commercial banks have grown sharply over the past few months, matching the aggressive growth exhibited back during the panicky days of late 2008:


24hGold - On the Brink of Infl...



Moving From Money to Price Changes: Some Pitfalls

Before the reader runs to the gun store (or jumps out the window) because of impending price hikes, I should go over some caveats. First, we must always consider the supply and demand for money. Clearly in late 2008, but also in recent months, the general economic outlook was very bleak and this led households and firms to increase their desired holdings of money (as opposed to other liquid assets). Rather than viewing the banking system as pushing new money into the economy, some economists would look at the above chart and see people pulling new money into existence (through the magic of fractional-reserve lending).

A second nuance is to contrast relative with absolute price changes. During late 2008, the official consumer price index (CPI) was falling fairly rapidly. Therefore, even though it may have been true that Bernanke's money creation led to "rising prices," this tendency may have been masked by the underlying fall. The net result was only a modest increase in CPI during 2009, which led many critics of Bernanke to look like Chicken Littles. The following chart shows what happened to CPI over the last ten years:


24hGold - On the Brink of Infl...


Note that in the above chart, we are not currently staving off a plunge in consumer prices, but in fact are following on the heels of a rather sharp surge in the official CPI.

A third caveat in our analysis is that (as good Austrians) we must remember that there are millions of different prices in the economy. The specific impact of money creation on various sectors can be very different, and operate on different time frames.

For example, during the present crisis, we had the Fed create more than a trillion dollars on behalf of rich investment bankers. At the same time, middle- and lower-class households were plagued by high unemployment, large debts, and underwater homes. In this environment, it's not surprising that the various rounds of "quantitative easing" went hand in hand with huge jumps in stock and commodity prices, but were muted in the retail sector.

Drawing on the Bureau of Labor Statistics' latest releases of the consumer and producer price indices, we see that once we leave the specific metric — "core inflation" — favored by Krugman and other prominent economists, we get a very different picture indeed of the trend in prices over the past year:

Price Change from July 2010 — July 2011

Producer Price Index — crude goods

22.6%

Producer Price Index — intermediate goods

11.6%

Producer Price Index — finished goods

7.2%

Consumer Price Index — all items

3.6%

Consumer Price Index — ex food and energy

1.8%


Conclusion


Austrian economists know to be wary of looking at financial data and drawing conclusions about what "must" happen. The future is always uncertain, the result of volitional human action.

It's also true that we have reason to be very cynical about the "official" data put out by the Federal Reserve and the Bureau of Labor Statistics.

Even so, my point is that the government's own numbers indicate that Bernanke's grace period may be ending. These trends might turn out to be a blip — only further observation will show — but we soon may see the Fed's "exit strategies" put to the test.


 

 

<< Previous article
Rate : Average :4.6 (16 votes)
>> Next article
Robert Murphy is an adjunct scholar of the Mises Institute, where he teaches at the Mises Academy. He runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism, the Study Guide to "Man, Economy, and State with Power and Market," the "Human Action" Study Guide, The Politically Incorrect Guide to the Great Depression and the New Deal, and his newest book, Lessons for the Young Economist.
Latest comment posted for this article
Be the first to comment
Add your comment
Top articles
Latest Comments
One more book, Mr. Stockman
11:02user4779
While it is true that "[Gold standards] were abused, suspended, and ultimately abandoned in favor of a currency that central banks could inflate at...
Panicked Hedge Funds Now Praying...
30 Junovertheedge
"... and the silly game theory ..." Obviously you have no knowledge of game theory and its applications. Otherwise you wouldn't have used ...
The Gold Standard: Generator & P...
30 Junuser4779
Is it really so bad for Americans that they do not spend their lives labouring on a production line to make mass-produced goods, and have left this...
The Gold Standard: Generator & P...
30 Junsam_site
You state, “To continue selling to the West, China will have to open wide its doors to imports” Here’s the crux of your argument of why Chin...
The euro crisis
30 Junovertheedge1
"There is no immediate benefit from debating why." Debate? That would be like debating whether or not gravity exists. You stated the obvio...
The Ultimate Confirmation
29 Junovertheedge
It would appear that we share the same conclusion. A few sealed cans of kerosene might be handy as well. Thumbs up sir.
The Ultimate Confirmation
29 JunS W.1
My main sentiment here is why swap dollars for gold or silver only to sell at some later date for more dollars when that same paper is continually ...
The Ultimate Confirmation
28 Junovertheedge1
Well, gotta admit that there is a problem if a person tries to play silver as both an investment and as an insurance policy. I would suggest th...
Most commented articlesFavoritesMore...
World PM Newsflow
ALL
GOLD
SILVER
PGM & DIAMONDS
OIL & GAS
OTHER METALS
Mining Company News
Helix(Ag-Au-Co)HLX.AX
R & D Tax Rebate Received
AU$ 0.04+28.57%Trend Power :
Corporate news
HannansHR9.BE
Sale of Exploration Database
€UR 0.00+0.00%Trend Power :
Corporate news
Arch Coal(Au-Coal-Cu)ACI
SHAREHOLDER ALERT: Levi & Korsinsky, LLP Announces an Investigation Involving Possible Violations Concerning Arch Coal, Inc.’s 401 (k) Plan-- ACI
US$ 0.33-2.94%Trend Power :
Corporate news
Mindoro Res.(Cu-Ni-Zn)MIO.V
Mindoro Announces That Bridge Loan from TVI Resource Development, Phils. Inc. has Not Been Extended
CA$ 0.01+0.00%Trend Power :
Corporate news
Bannerman(Ur)BMN.AX
Change of Director's Interest Notice - L Jubber
AU$ 0.05+4.08%Trend Power :
Corporate news
Peabody(Coal)BTU
Mid-Day Market Update: Chubb Surges Following Announcement of Acquisition by Ace; Ballard Power Shares Decline
US$ 1.78-18.72%Trend Power :
Corporate news
Peabody(Coal)BTU
Mid-Morning Market Update: Markets Open Higher; Constellation Brands Q1 Profit Tops Views
US$ 1.78-18.72%Trend Power :
Corporate news
Asian Mineral Res.(Co-Ni-Cu)ASN.V
Asian Mineral Resources Announces Appointment of Director
CA$ 0.05+0.00%Trend Power :
Corporate news
AlstomALO.PA
Alstom’s Citadis Dualis enters service on the Nantes-Clisson line
€UR 25.73+1.10%Trend Power :
Corporate news
Range Res.RRS.AX
Why Range Resources (RRC) Could Be Positioned for a Slump - Tale of the Tape
AU$ 0.02+0.00%Trend Power :
Corporate news
Comments closed