This is a follow up to some of the comments to the post Welcome to a Free Money World!
From the post Money Supply, Hoarding, Gold, Deflation: Tin Foil Hats: "For the hyperinflationists out there, a massive increase in money supply IF IT IS HOARDED would still result in deflation."
The above chart from the Federal Reserve Bank of St. Louis is of Excess Reserves of Depository Institutions (EXCRESNS). This rather large and sudden jump can only signify one thing: BANK HOARDING.
Bank hoarding can also be seen via the absolute collapse of money velocity. Just take a look at the M1 Money Multiplier (MULT) from the Federal Reserve Bank of St. Louis. Banks don't lend, so you can't spend. Everything stops.
Stare into the abyss of deflation. All the money in the world is useless if it doesn't move...
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How long do you expect money not to move though? It's obviously not sustainable in the long run.
If spreads ever tighten to a non-crisis level, or the gov't starts doing helicopter drops, people are going to spend and or invest in projects, and with rates exceedingly low, there's going to be excessive demand for credit.
Or alternatively, if deflation sets in and prices and wages continue to drop along with expectations continue along those lines, at some point there has to be a nonzero bottom to the deflationary spiral when that hoarded cash starts making its move.
Or alternatively, if the market stays seized up and the gov't just keeps printing more and more supply, how long until the printing to service it's own debt reaches a catastrophic tipping point.
Do you think the Fed will be able to whipsaw in and out with the rates and stimulus in perfect time to prevent an inflationary spike, especially when they're basically daring people to bet on inflation by saying they'll leave rates low for an extended period of time?
This is obviously a transitional time- whether the outcome at the end is recovery or currency collapse or hyperinflation or just a long zero growth lost decade remains to be seen.
Ba-ba-ba-bingo.
To me this does, however, SLOW deflation. If the banks didn't have these reserves from the Fed they'd have to call in loans which would be insanely deflationary.
So while it's definitely not inflationary, it does slow deflation a bit.
IDB: "If... the gov't starts doing helicopter drops, people are going to spend and or invest in projects"
Uh, no. The definition of a liquidity trap is that the multiplier is exactly 1. Meaning that every $1 inserted into the economy creates exactly $0 in either 0% high-quality investment, or $0 in 10% low-quality investment, or $0 in additional spending. A liquidity trap is an underlying lack of spark, not a lack of fuel.
Illustration: I encourage the gov't to mail me $1000 in stimulus in 2009. After tax deductions, I will insert $1250 of additional funding into my HSA where it is 100% tax avoidance (not even deferred) and liquid. If HSA is maxed, I will move to the less liquid shelters like 401k. If those are maxed, I can always pay down some mortgage or try to get a sweet govt-sponsored refi.
"if the market stays seized up and the gov't just keeps printing more and more supply, how long until the printing to service it's own debt reaches a catastrophic tipping point"
Good question. Japan started their fight against deflation approx 1990 with stong surpluses. Almost 20 years later, they are left with mild deflation, a 20 year slump, and national debt in excess of 160% of GDP. In contrast, we started with national debt at 60% of GDP, and even before this hit were expecting debt of +200% GDP within 30-40 years.
"Do you think the Fed will be able to whipsaw in and out with the rates and stimulus in perfect time to prevent an inflationary spike"
No. Expect short-term deflation, hedge for a craxy ride afterwards, and forget about equity capital gains. Yield is the new capital gain.
FN, does that chart show excess reserves (that is, unmultiplied base) growng by 1.4% of GDP? And (doing the magical economic holding everything constant thing) doesn't that imply a 12%+ decrease in GDP? Yikes.
Taiwan announced a consumption voucher program where they will distribute vouchers that expire at the end of 2009 as a way to ensure that stimulus is spent and not hoarded. They don't seem to fully understand the concept of fungibility.
Any mouse: "Uh, no. The definition of a liquidity trap is that the multiplier is exactly 1. Meaning that every $1 inserted into the economy creates exactly $0 in either 0% high-quality investment, or $0 in 10% low-quality investment, or $0 in additional spending. A liquidity trap is an underlying lack of spark, not a lack of fuel."
What I'm saying though, is that although you may do that now, ior in the short term future, it's not sustainable. The amount of stimulus (as well as the debt load) the government is providing scares the crap out of me.
The money won't sit indefinitely. If spreads drop to something non-ridiculous, or people are just spending helicopter money on food and expenses, and your hoarding is safe but only giving you small returns, at some point extension of credit an investment will return as prices drop and the stockpile of money is balooning.
And fast, given the level of supply sitting there waiting. That money sitting on the sidelines is going to pour into anything creating any kinds of returns. And that excessive money supply is going to drive up prices, and returns, and more money that was on the sidelines is going to start playing chase.
In my opinion, probably faster than the Fed can tighten and remove their injections, especially when they're doing quantitative easing *and* promising to hold rates low.
You say "Expect short-term deflation, hedge for a craxy ride afterwards" and I'm pretty much in agreement. That crazy ride may or may not include hyperinflation, but I wouldn't rule it out at this point. If you would have asked me 3 years ago if I would see hyperinflation in the US in my lifetime, I would have thought that was a "tin foil hat" notion. Not anymore.
Ben,
What do you think of an opinion presented by Caseyresearch.com?
We believe the excess reserves by the banks will be lent to the public, not private sector. While some money is starting to be used for lending (Verizon was recently able to receive a $17 billion loan to refinance debt in the largest debt offering this year), we believe banks continue to be too weak and don't think the private sector is strong enough either. Further, the unprecedented amounts that need to be financed next year by the U.S. government will crowd out the market: there may not be enough money for the refinancing of U.S. corporate, European corporate or emerging market corporate and government debt available, keeping the cost of financing high for all those players.
The Fed will be aggressive at lending to those sectors of the economy where it wants to see borrowing costs low. The Fed has announced it will buy agency securities (Fannie & Freddie mortgage securities to keep the cost of home ownership low), Treasury bonds and, according to the Fed minutes released December 16, 2008, will "consider ways of using its balance sheet to further support credit markets and economic activity." Using the balance sheet means to issue cash created on a keyboard to buy assets in the markets.
http://www.caseyresearch.com/library/articles/2453/fed-fights-to-weaken-dollar-12-17-08/
If *I* was one of the anointed few getting all those USD handed to me for free, instead of bothering with the crooks at Wall Street, I would be busy exchanging it for EUR/DKK and sticking it in the bank for that fat 6% interest!!
Even my boring local bank pays 4.5% on a current account. Deposits are insured 100% by the Danish taxpayers - due to the "Financial Crisis".
Indeed; why would a bank NOT borrow trillions of USD from the FED and use it to break the USD like Soros did to the GBP??
It's totally risk free: Even IF the market goes against their USD short position the FED will buy them out "to stabilise the financial system".
The "No Inflation "IF IT IS HOARDED"" only applies as long as the USD does not tank.
Once it does the US will see PLENTY of inflation in all imports ... and deflation in the economy that earns the money to pay for it. At the same time. Crunch!
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The General Theory of Employment, Interest, and Money,
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Quoted by Chairman Sir Alan 'El Maestro' Greenspan
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