Understanding Bernanke
July 2, 2008 – 12:57 am
If skyrocketing food and oil prices point to inflation on the rise, then why has the Fed risked even more inflation by lowering interest rates so much since last Fall? That’s a popular question these days. And one that’s hard to answer without knowing how the Fed works.
The trick to understanding the Fed is to have a basic understanding of inflation itself.
Generally speaking, inflation is considered to be an increase in the price of goods and services over time. One cause of higher prices is an increase in the supply of money relative to the amount stuff money can buy.
Say, for instance, the government decided to give every American citizen a million dollars tomorrow. Everyone would race to spend their windfall and prices would move upward as a result. No one would be any wealthier in terms of the AMOUNT of goods they were able to purchase. People would just have to pay higher prices for the same stuff they buy every day.
More money => higher prices = inflation.
So more money causes inflation. But what is money and where does it come from?
Defining “money” is tricky. The government has multiple definitions, all of which are considered inadequate by some. One way to conceptualize money is to think of it as anything that can be used to buy goods and services. Cash is money. So are the deposits in your checking account, which can be spent via checks and/or debit cards.
Now consider that the source of the money in your wallet or in your checking account may be more than simply your weekly paycheck. The source may be a line of credit. The bank can give you cash to spend today (via a home equity loan, a student loan, etc.) so long as you agree to pay it back in the future.
Banks literally create money this way. Say you deposit $1000 in the bank with your next paycheck. The bank is required to keep only 10% in reserve and is free to lend the remaining 90%. That means the bank can lend $900 of your money to someone else. And what happens to that $900? It will likely end up as a deposit in the borrower’s bank account. His bank, required to keep only 10% in reserve, may lend $810 to another borrower. The process continues until no more money is available to lend. In this way, your $1,000 deposit in the bank is turned into $10,000 of total money in the economy. (For those interested, additional reading here and here)
U.S. GDP is driven almost exclusively by the “spending” of households, businesses and the government. And much of that spending is driven by whatever supply of money is created by banks. If banks supply the economy with too much money, the result is inflation. The housing bubble of the last five years is a perfect example. Banks supplied too much money to buy homes, and rapid house price inflation was the result.
Why would banks choose to supply more or less money? The biggest reason is whether they can lend money profitably. A bank’s revenues are driven by the interest rate they charge borrowers, 7% on a mortgage for instance. A bank’s costs are driven by the interest rate that they pay depositors, 2-3% these days. If the interest rate paid to depositors declines relative to the interest rate received from borrowers, then the bank makes more money and will be encouraged to lend more.
Summing up: a growing money supply is responsible for inflation, banks increase the supply of money based on the profitability of lending, which is largely driven by the interest rates they pay depositors. Therefore, he who determines interest rates has immense power to inflate or deflate the economy.
“He” is Ben Bernanke, the Chairman of the Federal Reserve Board of Governors.
If you’ve understood all of the above, you may have arrived at the question that is perplexing the Fed’s critics: why in God’s name is Ben Bernanke lowering interest rates, encouraging banks to feed more money into the system, when inflation (as seen in food and oil prices) seems to be accelerating?
Well, a big reason is that, when thrown in reverse, the money supply cycle detailed above ends up destroying money far more quickly than it was ever created. Recall the math: with a reserve requirement of 10%, banks need $1000 on hand for every $10,000 in loans created. If the bank loses $1000 (because a subprime borrower defaults on his mortgage, for instance), then the bank has to take $10,000 out of circulation.
This is the fundamental problem facing the American economy right now. Borrowers are defaulting on all sorts of debts at increasing rates. Home loans. Student loans. Auto loans. Credit cards. And, as the WSJ is reporting today, construction loans.
With all these bad debts collecting on bank balance sheets, one would think banks would be in no position to inflate the economy with more lending. Paul Kasriel, Chief Economist at Northern Trust, has published multiple reports over the last week demonstrating this fact.
Most interesting was chart 1 to the right, published in his report two days ago. That sudden and rapid decline seen all the way to the right shows: “the sharpest 13-week contraction in bank credit” since data were first available in 1973. Banks simply don’t have the capital on hand to avail “themselves of the cheap credit the Fed is offering to fund them at.”
This is what it means to be in a “credit crunch.” Banks have suffered hundreds of billions in losses, forcing them to pull credit out of the economy. Every time you read an article about banks cutting credit lines, exiting lending businesses, or eliminating mortgage products it represents more bank credit drying up.
Sure enough, as shown in this second chart that Paul published last week, the decline in bank credit corresponds to declining growth in the money supply:
As noted above, the amount of money in the economy available for spending is one of the chief determinants of economic growth. To the extent that money is rapidly drained from the system, through a credit crunch for instance, then the economy can experience a painful deflationary spiral that leads to recession (or depression). Bernanke is one of America’s foremost scholars of the Great Depression and is thus acutely aware of the economic risks posed by a rapidly deteriorating credit environment.
This is why Bernanke has lowered rates aggressively since last Fall despite inflationary pressures from rising oil and food prices. As he stated multiple times, he believed the risks of recession “outweighed” the risks of inflation.
Unfortunately, lower interest rates may do little to cushion the blow of the credit crunch. Despite cheap funding offered by the Fed, bank credit is declining rapidly.
And just because the domestic money supply is under pressure doesn’t mean that the global money supply can’t expand. Bernanke’s low interest rates encourage foreigners to sell their dollar holdings, putting them into circulation. See, for instance, the rapid flow of capital out of dollars and into Chinese Yuan. This is putting immense downward pressure on the value of the dollar, increasing prices for commodities priced in dollars.
The bottom line is that Bernanke inherited a VERY sick economy from Alan Greenspan, whose low interest rate policies earlier this decade encouraged a cycle of excessive, imprudent lending that led to the economic hangover we’re suffering today.
Posted in Dollar, Economy, Fed, Interest Rates, banking, credit crunch, inflation, tutorial |
31 Responses to “Understanding Bernanke”
There is really nothing to understand. It’s quite simple. Bernanké, like the damn politicians (except Ron Paul) are there to save their buddies on Wall Street first and foremost. The rest is of no importance. Save the bankers at any cost. Save us from a systemic crisis and pass the buck to the taxpayer and the middle class.
By Marc Authier on Jul 2, 2008
Marc–I think you’re right: This is a giveaway to the bankers to save us from a systemic crisis.
Interest rates are being raised on everyone except the banks themselves. A thoughtful reader sent me a note commenting that credit card rates are up, mortgage rates are up, the banks’ cost of new equity and debt capital is way up.
The only group getting the benefit of the Fed’s lower interest rates on deposits are banks themselves.
In my estimation it is a giveaway from the Fed that should improve bank net interest margins. But that’s probably the idea.
Bank capital is being hammered so hard and fast by huge writedowns that Bernanke is worried about the banking system utterly collapsing. 4%-5% inflation and negative real interest rates are not something any prudent saver likes to suffer through. But a bank system collapse (on the scale of the Depression) would make our present economic problems pale by comparison. Given the huge leverage factors we’re talking about here and the likelihood of hundreds of billions of additional writedowns coming, I think Bernanke sees a distinct possibility of a very large (system wide?) collapse in the banking sector.
That would feed a panic. Mini bank runs have happened at fairly large banks (CFC last year, IndyMac the last couple days). A large failure would cause more people to race to their banks to pull out funds. And given the obnoxiously large leverage ratios at some of these banks, they are in a very poor position to deal with the liquidity crisis that would result from a bank run. (It should be noted that the 10% legal reserve requirement mentioned in my post is kind of a joke, what with all the legal means banks have of shifting deposits to different types of accounts that don’t need to be reserved against at all).
The only thing Bernanke can do to avoid a bank system collapse, if indeed he believes that is likely, is to help banks replenish their capital by way of more profitable lending (higher net interest margins).
The rest of us pay for this policy choice via declining interest rates on our savings as well as declining purchasing power of our dollars.
Bernanke, I’m sure, doesn’t like the idea of reducing people’s purchasing power and rewarding banks for their poor behavior.
But he probably feels that is an ok price to pay if the alternative is for depositors to actually lose ALL of their funds (due to bank runs that follow a massive system-wide capital writeoff).
Hopefully we get through this crisis and the Fed responds by raising rates and tightening bank capital requirements significantly.
I think Bernanke knows he inherited a Fed that has turned a blind eye to financial institutions overlevering themselves. I think that’s a big reason he wants to start paying interest on reserves. That would reduce banks’ incentive to move funds into the shadow banking system, SIVs, etc. where they aren’t reserved against.
In the long-run, though, he’ll have to do far more than that to repair a banking system that is clearly broken.
By RolfeWinkler on Jul 2, 2008
excellent post.
As you know, there are those who call for an end to the Fed along with the fractional reserve idea, to eliminate the possibility of the kind of “what, me worry?” situation we were in.
Drawing from what you said, I infer that these ideas would result in a very limited economy, with banks having to cover themselves for virtually the entire amount of their deposits, being extremely caution about loans and charging high rates for those loans. In other words it would be permanently tight money, if my understanding is right.
I wonder if you think this would be a workable scheme.
By CB on Jul 2, 2008
A great question. Certainly that’s Ron Paul’s idea along with his supporters in the blogosphere that want to abolish the Fed entirely and move to a gold-standard.
I’ve yet to go that far in my critique of the Fed. Perhaps because there’s too much I still don’t know.
Some argue that a little inflation is a good thing, encouraging economic activity. A good parable here
By RolfeWinkler on Jul 2, 2008
How can they say that ? It’s just that you did not experience in the US what they experienced in Mexico, in Argentina, in Turkey, in Russia, in Brasil, in South America, in Indonesia, in Malaysia, in Thailand. The last 30 years, there has been 20 major monetary crisis. Oh yes. It can happen and it will happen in the US or even in Europe. The 2008 USA, is quite different from the US of the 70’s or the 80’s. A “little bit” of inflation ? Real inflation is about 8%. Please. Don’t tell me you believe the crap produced by the Labor Department ? This ENRON administration in Washington is lying. What’s next ? Try the Weimar Republic.
http://www.youtube.com/watch?v=dpDgrvYd36k&eurl=http://www.itulip.com/
By Marc Authier on Jul 2, 2008
I think you misunderstood my last comment Marc. Clearly the amount of inflation we have today is unacceptable over the long-term. And clearly the Fed is following a risky course by lowering rates as inflation accelerates.
That a “little bit” of inflation can be a good thing is a point Krugman made and, while I can’t claim to know what’s in his head, I bet he means inflation of 1% or so is probably good. Certainly nothing like the level we’re seeing today.
And while I certainly think that’s a valid point that should be considered, I’m not saying I necessarily agree with it. Hell, we only had a “little bit” of inflation during the last years of Greenspan’s tenure. But only according to his chosen measure, the CPI. Was the ridiculous bubble in housing prices not an example of runaway inflation???
By RolfeWinkler on Jul 2, 2008
I have heard this argument numerous times. And frankly it’s really beginning to annoy me. OK. So the excuse for destroying the savings of people living on fixed incomes and taking food out of the mouths of the poor by inflating food prices is to save the banks…because if the banks fail, everybody loses. Hmmm. Well, most of what I have heard from Bernanke is how we’ve had such strong fundamentals and how risks to the economy from the credit crisis have been contained. And how housing fundamentals were strong and that a ‘moderation’ in housing price increases was the likely outcome. And how he doesn’t expect inflation to have a significant effect on the American consumer. And how there are no significant risks to the ‘large international banks’ that make up such a large part of our banking system. But now you are saying that behind the scenes he’s known all along what a mess everything is. I guess that makes every word of his Congressional testimony over the last two years amount to a pile of lies. But let’s put aside that Bernanke put up 29$ billion in taxpayer-backed dollars to hand Bear Stearns to JP Morgan on a silver platter without consulting Congress and that now it turns out that a significant amount of their assets were created by a recently apprehended criminal enterprise. And let’s accept the premise that you are right. But before we start taxing the poor through inflation to bail out Wall Street, let’s have a nice long talk with Mr. Bernanke, Mr. Greenspan, and their cohorts at Lehman, Goldman, JP Morgan, etc and have an honest admission of how this mess got created and just how extensive the damage is. Maybe a few of these folks will have the courage to stand up and take some responsibility for this catastrophe. Then we can discuss how to fix the problem in the best interests of the greater good. A little honesty would go along way. But right now I don’t see Mr. Bernanke and the bankers on Wall Street offering much in the way of responsibility or honesty. Has one person at the Fed come forward and said “Sorry we made a mess of this. Now everyone is going to suffer but we are going to do our best to fix things and make it right”?
By jgl on Jul 2, 2008
A little honesty ? Please. This is of no importance. I saw the same pattern when Greenspan created the internet bubble. And you see the same horrible behaviours today. 500 billion of NINJA loans is no accident.
Same thing with the exotic products. They couldn’t care less. And if tomorrow morning they can start again the will. Neo-cons in Washington and no regulaion gave us this and it will give us 1929 or even worst all over again.
Honest admission ? You will have none of that. “Sorry we are a bunch of crooks and liars, and we promise from now on, we will not do it again.” Yeah sure. You are dreaming. And anyways they couldn’t care a hoot like your politicians in Washington.
By Marc Authier on Jul 3, 2008
That’s right. A banking collapse will not be worse than hyperinflation. A few strong, conservative banks will survive and can handle the load, especially with online banking and an increasingly paperless economy. And besides, the taxpayer is already on the hook for 100,000 + 500,000 in securities. LET THEM FAIL
By squashnut on Jul 3, 2008
And if you get hyperinflation, you will have both. Hyperinflation didn’t help the banks during the Weimar Republic. Better fail than hyperinflate. Here a refexion. You hyperinflate and oil goes to 500$. You would have instead failure of the whole economy instead. GM, Ford and Chrysler are already going bankrupt, so imagine in hyperinflation what happens to the rest.
By Marc Authier on Jul 3, 2008
I disagree with two points: Item 1) What is money? In the USA, Money ONLY represents the promise to pay a debt to a bank. Nothing more nothing less. This is the operational definition of fiat currency under the Federal reserve system. Without debt, we don’t have a banking system. Its as simple as that. Banks have always had an element of this but have changed over the years from the business of banking (implying caution, savings and prudence) to an institution that ONLY cares about selling loans or debt. Banks don’t want or need deposits!!! If they are getting such usurious interest rates on signature loans, why don’t they pay interest? Because they don’t need it. As long as people are sending in their interest checks banks don’t care. Banks want to sell the “promise” of wealth via publicly held stocks and/or they act only as loan companies. What happened to banks as banks?
Please Google the video: “Money as Debt” Our fiat currency, the US dollar, has NO value but the value that banks give it via a promise to pay - the signature by a debtor. The second a signature bank loan is appproved by the bank, is the second that money is created. Usually this money is initially in the form of a check by the bank, which is another promise to pay the debtor with US dollars for exchange of the check. No printing press is required. The bank settles its reserve accounts on paper or computer and that is transmitted to the local regional Federal Reserve bank. The Federal Reserve is only an association of banks which agree to the monopoly or cartel. The problem we face (citizens, academics and politicians) is not understanding this fraud. Once we understand it, the system will be shut down. The Federal Reserves biggest fear is that people understand it.
Item 2) Theoretically banks are supposed to have a 7-10% reserve on deposit. However, the REAL rate is more like 40-60:1 This is terrible. If there were a run on only a few large banks, the FDIC, the Federal Reserve system and the Office of Thrift Supervision could NEVER handle it. We would have a complete collapse of our banking system as we know it. The FDIC (Federal Deposit Insurance Corporation) has NEVER been an insurance company and has very limited assets. It insures NOTHING. The only money THAT it can give you- if it had the money - is devalued or no VALUE FIAT CURRENCY - which is nothing but paper with green ink on it. Our dollars have NO INTRINSIC or real world value. When an FDIC bank fails, it is given too many chances and it fails again….we have over 150 of them that are failing as I write this. The FDIC simply transfers the debt and assets to another bank, which has its own unenforced policies about how to settle its accounts. This is a classic PONZI scheme. The hope is that most depositors won’t run on the bank, and that transfers the risk to another bank and dilutes the time value of the money on deposit. Ask yourself what happens if depositors refuse to leave their money in the new bank? That bank will also most likely fail. And the process repeats itself like a chain letter. There are a few ways to break the chain. 1) Destroy the money or hide the money. 2) Don’t spend any money. Don’t save it–Don’t deposit it.
Think of this. The power of the Federal Reserve and its member banks could be reduced to zero without any political intervention. All you need to do is slow or stop the movement of money through the system. It is that simple. Bankers and the Federal Reserve get enormous power over us because we either spend money, borrow money or deposit money. banks ADD NO VALUE TO OUR LIVES. They are like a form of taxation. Everytime they touch our money, they get some for themselves—only because they touched OUR money. Did they add value? No. Did they extract value? yes! What is the value of a bank if it is only a loan company? NONE! — and thats what banks have become—LOAN COMPANIES. Walk in to a bank and tell them you want to make a savings Deposit. you are tgerated like a criminal. They want you tto either sign up for a loan—making them money. Or “invest” in a CD or other trickery so they can use your money to make big money for them and they can hold on to it while you have lost liquidity and the value of the money. DFon’t believ me? Try using a CD as collateral for a loan. LOL They will laugh at you. If you want some money get a mortgage. They still originate NO MONEY DOWN LOANS. Have you ever heard of the “Nehemiah program”? LOL
The complex and convoluted methods that banks use for accounting methods could NEVER be legally used by individuals or private businesses—but only for banks. The reason? because it is a Super Ponzi scheme. If you have only a promise to pay a debt—that is not a real value. What is the debtor HAS NO ASSETS? Or the next debtor, or the next debtor? That is in essence whay is happening when houSes lose selling price “value’. The problem is that the Federal Reserves artificially low interest rates, has made the “value” of the loan worth more than the “value” of the house. So people with NO income and No assets bid up the asking and selling prices of houses way above the value of the property. As the bubble deflates, people will walk and the banks are stuck with overpriced houses that many people don’t want. Old termite infested hosues are not much of a value especially not the million dollars debts they may represent.
By Ben Bukkake on Jul 4, 2008
Somw of my statements may be difficult to understand. So I quickly looked up three banks that are on the precipice of disaster. Mr Paulson has been handholding them, Mr Bernanke has been massing them, bit they are failing. It can not be stopped. I beg of you, dont listen to me, I will give you stock symbols of three banks, look them up. Study the bank profiles and look at only the last years worth of stock prices. A good start for some is Yahoo, click on Finance and the stock ticker symbols as follows: Please you only need to spend maybe 10-15 minutes on each bank and you will be so shocked you will start calling up your political representatives to find out WHAT THE HELL IS GOING ON? Where is the news media? Where are the regulators? We are actually watching a slow rape of our country. If you have probelms understanding the market quotes ask a knowledgeable friend or better yet any banker. They will freak out! How can this be true? We have smart bankers, accountants, computers, research but NO ONE is saying anything abiout it. Remember you read it here first.
Look up the following:
1) Bank United Financial Corporation: “BKUNA”
This is a poster child of most everything wrong with banks. You could write a movie about it, after only 10-15 minutes of reading its history. We have intrigue, nepotism, its all there. Started 12 months ago at $20.48 its bobbling along the floor below one dollar. They have BILLIONS in debt. Google Minyanville and BKUNA.
2) IndyMAC BNCP INC: “IMB”
They started 12 months ago at $31.50 and now they are down to $0.56 per share. Too mnay problems to go into it.
3) Wachovia Bank” “WB”
One year ago $53.10/share today $14.88
Read the Yahoo message boards. Peole are losing evrything. But this is not in the media.
4)AMBAC Financial Group “ABK”
Last year $88.06/share, today skiding along at 41.30/share.
What the hell is going on? Where are the regulators? All we hear are cheerleaders.
By Ben Bukkake on Jul 4, 2008
Sorry ABK is now $1.30/share can you believe it?
By Ben Bukkake on Jul 4, 2008
I believe keeping the interest rate low is a bad idea for the banks. Here’s why. Let’s say someone defaults on a $500K mortgage at 5% interest 30 yrs. The bank cannot sell the asset at $500K because it wasn’t worth the $500K to begin with. There are plenty of buyers sitting on the sidelines waiting for the price of the asset to decline. There are even people thinking of mailing in their keys to the bank and crossing the street to purchase the same house at half the price. So, what happens if the bank sells the asset for $200K but at 15% interest 30 yrs. The bank will have the same cash flow- a monthly payment of $2660 (approx) over 30 years. Now shouldn’t the bank rather loan 2 1/2 people $200K at 15% or instead loan one person the same $500K at 5%. I don’t believe this money deflation is about housing and mortgage defaults. What is really going on is that the government is deflating our currency in reference to the Chinese currency in hopes that the Chinese consumers will buy our goods. Just think, 2 billion Chinese drinking soft drinks, Starbucks …everyday. I believe the Chinese will never buy our goods, just as the Japanese never did. Our biggest export is jobs. Ben should raise the interests. Let the house prices crash, let everyone purchase the assets at a reasonable price (at higher interest rates) and forget about the Chinese. The Chinese will never buy what little we manufacture anyway. Why should they? They make everything now anyway. The only other thing I can think of is that the government is trying to cheapen the currency so someone that purchased a $500K shack doesn’t feel so bad and keeps paying the mortgage. But to do this would mean $15 per gallon gas. An apple for $5… Then $500K doesn’t look so bad for that $120K house. The problem with the former idea is that I haven’t seen the companies increasing our pay in multitudes. So, I really rule the last idea out. It won’t work.
By Jose Perez on Jul 4, 2008
Then Jose, houses would be affordable, but what about the bonuses at JP Morgan and Goldman Sachs ? I have an even better idea. Let all these banks fail. Then send a nice big check or loan directly to the taxpayer, so he can buy the cheap houses. Nah! It would be communism ! Helping Bear Strearns and JP Morgan wasn’t communism, it was crony capitalism done in the name of saving the people from systemic risk. Funny. I don’t think It will change something for GM workers or poeple defaulting.
By Marc Authier on Jul 4, 2008
Ben….if you’re interested in the ugly details about BKUNA, you could also see my post here. It’s rather up to date with their latest scam: wiping out existing shareholders by selling 10x as many new shares as are currently outstanding. The post also has details regarding the “nepotism” to which you refer.
By RolfeWinkler on Jul 4, 2008
Inflation is an increase in the money or credit supply. Rising prices are a result of inflation since with more money in circulation, each dollar has less value, so you need more dollars to by a given quantity of goods. You’re confusing cause and effect.
By John on Jul 4, 2008
John….not sure I understand your point. I’m not claiming that rising prices cause inflation. Perhaps you misunderstand the mock equation near the top of the post. I’m saying higher prices and inflation are, more or less, the same thing, and that both are caused by an increase in the amount of money competing for a finite amount of goods.
By RolfeWinkler on Jul 4, 2008
Yes I saw that one. Its an excellent article. Where is the SEC? Where is the FBI? Where is Paulson hiding? Bernanke?
I commmented on it while flying my “Gulpstream jet” LOL
By Ben.Bukkake on Jul 4, 2008
I agree with the most of the posts that Bernanke is taking food out of people’s mouths. What is upsetting is to see the banks still behaving like they are in control. We are subsidizing their reckless behavior and they still refuse to acknowledge balance sheet risks. And to top that off a lot them are still paying dividends while they are close to or virtually insolvent.
The Fed needs to stick it to them (banks) so they will make the drastic moves necessary, Let the banks manage their way out of this situation. We can survive some of them going belly up. Our Fed is being held hostage by these incompetent banking execs.
By mike dunn on Jul 4, 2008
Nonsense. The inflation we have today is about oil. Dead stop. If it were a monetary inflation you would see prices rising across the board. The prices increases are not monetary in nature, thus they have no monetary solution. Sure you can raise rates a couple points and mass murder the banks, and kill the economy. That will bring prices under control. Talk about costly though.
By Mark Sanford on Jul 5, 2008
Good read Rolfe. The other foot to fall in all this is our federal deficit spending. What, 2 X 10 to the nineth dollars a day? We depend on the charity of foriegn governments and their trust in us to pay our bills. Heaven forbid they get enough and stop taking our dollars. We now import over 60% of our life-blood… oil. If Arabs get tired of supporting us and drop the dollar peg we are done. Some say they have too much to lose (they have too many of our dollars and can’t afford to let their value drop). Perhaps, but that is a big bet! I think a large part of the oil price reflects their discontent in our liberal money policies.
By Jeff on Jul 5, 2008
Mark, you raise an interesting point about oil. But I would argue that the inflation in oil (and other commodity) prices is itself monetary. You may have seen the report the other day that the Chinese negotiated a higher price for Iron ore with BHP. China, of course, has nearly $2 trillion of dollars in reserve which they can spend however they like. As they flood the market with cash to buy commodities, that’s totally inflationary: more money chasing a finite amount of goods.
I fail to see how the Fed has to print more money RIGHT NOW in order for the supply of money chasing goods to increase. Isn’t it possible for previously-printed money, having built up in reserve accounts worldwide, to lead to inflation today?
I’m thinking potential energy vs. kinetic energy. The Fed prints, foreign central banks (and other savers) accumulate. Incremental money can be added to the system without increasing prices so long as that money isn’t chasing goods/services. That is, as long as the incremental money is saved. It doesn’t become inflation in motion until it’s actually spent, until it is put into circulation.
As the Fed lowers interest rates, it turns potential inflation into kinetic inflation. Foreign savers no longer have an incentive to save their dollars so they start to spend them. The supply of dollars chasing goods/services increases, which is inflationary.
By RolfeWinkler on Jul 5, 2008
Fed is not printing money. The way if effects fed funds rate is to print monetary base money to buy treasuries. It’s not doing. Just go to it’s website and see. The fed is following the bond market, not artificially pegging interest at 2%. If you want to blame a central bank for inflation, blame the People’s Bank. They print yuan, trade it for dollars, to keep their currency weak, then buy treasuries helping keep rates low here.
By Mark Sanford on Jul 5, 2008
Ok people let me break it down for once and for all. The answer is simple.
The feds are destroying the currency for the purpose of an easy transition from the Dollar to the Amero.
Please be kind to the Mexicans and the Canadians. We are all in this North American Union together.
By ray on Jul 6, 2008
This is all part of the plan, don’t panic. Survival of the fittest. The smart people got out months ago. After all, did the people that matter get wet when the Titanic sank?
By John on Jul 6, 2008
I fail to see how the Fed has to print more money RIGHT NOW in order for the supply of money chasing goods to increase. Isn’t it possible for previously-printed money, having built up in reserve accounts worldwide, to lead to inflation today?
So, would that mean that Americans could put vast amounts of money in savings in order to curb inflation? Basically ‘capturing’ currency and judiciously ‘releasing’ in order to stimulate growth?
By Lisa on Dec 15, 2008
Lisa….re-reading what I wrote I think I should qualify what I said. The point I made was basically that money saved is money not chasing goods/services and is therefore not leading to inflation.
I should have said that if it isn’t chasing goods/services then it isn’t leading to inflation FOR GOODS/SERVICES. Saved money can indeed lead to inflation in the price of assets. The housing bubble is Exhibit A. There was too much money chasing houses, so prices shot past intrinsic value.
Economists have spoken of a “global savings glut” that drove down interest rates and drove up asset prices over the last few years. Too much money chasing too few assets. In fact there was so much money chasing assets that at the beginning of 2007, the aggregate price of EVERY asset class was at/near its peak. I’ll never forget seeing the chart in the WSJ Money/Investing section that showed the stock MARKET of every nation near record highs.
Check out the first op-ed I wrote from 3/07 under Top Posts on the main page. Same theme.
Would soaking up savings cut down inflation pressures? It would for good/services, all else equal. Higher interest rates have a dual effect in this regard. First and foremost, higher rates discourage borrowing, which halts the growth of money. At the same time, it encourages folks to save their money by offering better returns on savings.
By RolfeWinkler on Dec 15, 2008
Can you have high interest rates with low inflation. High rates based on a real scary default rate. Because usually high rates are based off high inflation.
Can the Government control and manipulate or push for low interest rates? Can they control the rates for 30 year bonds.
How come rates were so high in the early 80’s was it inflation premium, or did the Government try to push the rates up?
By Dave Triol on Feb 16, 2009
Inflation premium, Interest matuity risk premium, default risk premium, real rate of (profit) interest,
By Dave Triol on Feb 16, 2009