Why Inflation Won’t Be Back Anytime Soon
November 03, 2009
– Comments (3)
For this, Bob Brinker gets credit, because he is correct. Yes, the Fed is printing money as fast as they can change the ink cartridges on the presses. However, much of this is on ice at the central bank, where it cannot cause inflation.
Think of it this way: the year is 1932. A worker comes home with $10 in his pocket, a couple of weeks of wages. He can stick in his mattress (because he no longer trusts banks), or he can deposit in the neighborhood bank (because he gets interest, which will feed his family). If he chooses the mattress, money disappears and economic activity goes down; if the bank, the bank will turn around and lend to finance a small business’ inventory or give a mortgage to someone trying to buy a house.
There are several newswire stories that several major banks have $200B+ on deposit at the Fed, earning maybe a couple of basis points. They seem to be squirreling away the cash as capital reserves and liquidity hedges. Here, the banks have chosen the mattress. Recall the velocity theory of money
(money supply) = (monetary base) x (velocity multiplier)
Yeah, the Fed is increasing the base, but this money has V = 0, because it is in a vault, causing zero economic activity. Some analysts say that so much cash in reserve is a drag on bank profits, since these dollars are not being lent out, where it makes profit for the bank.
With so much more monetary base, many investors are betting on inflation. But as long as these dollars stay where they are, there will be no inflation. The flip side is that the Fed will have no influence on the reappearance of inflation. When this money moves out, it really won’t matter if and when the Fed takes away the punch bowl.
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