What if they had an inflation and nobody came?

PDB and Uncle and Kevin are flipping out about this chart, and they should:

I noted that trend back in December. Note the already-dated Ron Blagojevich joke: “The Fed is inflating the money supply to the mother-Blagojeviching moon.”

Thing is, the money supply has inflated, but price inflation hasn’t come, and may not for some time. Instead, we’re still seeing lower housing prices, energy prices, and stock prices. Other consumer prices are being forced down by excess and liquidating inventories. The consumer price index declined the most since 1947 and household savings went up for the first time in ages.

Not that the Federal Reserve isn’t trying. Watch this animated GIF of Federal Reserve injections since its founding to see just how unprecedented this money supply increase is by any historical standard. The Fed has never pumped this much money into the economy and to so little effect. (You may need to reload the image to see the whole thing, or you can go here to see a YouTube video clip.)

Or if you prefer inflation-adjusted charts:

I’ve said elsewhere that inflation won’t happen until the recovery phase, that the recovery phase can’t happen until after we hit bottom, and that we’re nowhere near hitting bottom. Right now the Fed is so afraid of deflation that they’ll spend any amount of money to stop it and have basically put interest rates to zero.

So what are the banks doing with all of the low-interest money the Fed is injecting into the money supply? Sitting on it. The banks know how awful their financial situations are. They know how bad option ARM recasts are going to be. They know what’s going to happen to the asset side of their balance sheets when all of that overpriced real estate enters foreclosure and they have to mark a $500,000 California mortgage down to the $300,000 the house will fetch on today’s market. They’re holding onto the TARP money so that they can bail themselves out, not other people.

The banks are like over-extended homeowners who get a credit card offer in the mail. They won’t put anything on the credit card because they know they already have an oppressive mortgage, two car payments, and a pile of credit card bills. If they grab the lifeline it will pull them down further.

Many banks are no longer healthy. That’s why so many of them had to be bailed out. Many banks bought up real estate and built new branches the same way everyone else did – by overleveraging themselves. They can’t repay all of their deposits and neither can the FDIC. The government is trying to keep the lid on things to prevent bank failures and a run on banks.


22 Responses to What if they had an inflation and nobody came?

  1. Pingback: SayUncle » Speaking of cheap money

  2. Brian D. says:

    Good overview of the problem. I’ve stayed off the housing market for years after doing the math in 2004 and thinking that people were just crazy.

    I’m still getting creamed, though, since the inflation will render my saved-up down payment pretty useless unless I buy a house at the right time. If the Feds pass “home-owner bailout” bills, then I’m royally screwed.

  3. Rich Hailey says:

    The fact that the banks are sitting on the cash is the only thing holding off inflation. As long as the money stays out of circulation, it’s as if it was never printed. That’s the genius of the initial plan in action. The additional case improves the asset ratios of the troubled banks, keeping them from melting down. As you said,when the mortgages default, the banks have the cash on hand to ride it out.

    If the money goes into circulation, game over. Inflation will go nuts.

    To make matters worse, the Obama economic stimulus plan will inject billions in newly printed currency into circulation, triggering inflationary pressure.

    Rich Hailey´s last blog post..Talking with Your Enemies

  4. Les Jones says:

    Oh yeah. Mild deflation is the present. Inflation is the near future.

    The .gov isn’t done pumping money into the system. With enough money they can inflate as long as the Asian economies are willing to buy U.S. Treasuries.

  5. Pingback: Instapundit » Blog Archive » LES JONES: What if they had an inflation and nobody came? I’m still trying to figure out if this i…

  6. Pink Pig says:

    There are two ways of looking at it:

    1) Wow, the country has really gone to pot in the last few months.

    2) Can you believe that they’ve been lying through their teeth for the last 80 years?

  7. Sean says:

    This is some grim shit.

    Where’s a good place to put your money in anticipation of the coming inflation?

    If your investments took a beating the last year and a half, what will happen to them after this shit hits the fan?

  8. Don Meaker says:

    My investments are doing well. Small, high density, useful, and even some chance for value to increase through increasing scarcity.

    Assemblies of Walnut, Steel, Brass, and Lead.. and propellent. Comes in a variety of sizes, and selections can be stored safely about the home.

    Don Meaker´s last blog post..So Sorry

  9. Seerak says:

    As you said,when the mortgages default, the banks have the cash on hand to ride it out.

    The problem there is that this is still inflationary, eventually.

    Suppose A defaults on his mortgage. Without any bailout, that means bank A no longer has on hand all the funds listed on its deposits. That means that there is a gap between “real” deposits, and what the books say exist. The bank is now insolvent.

    So now the government gives new dollars to the bank so that all the deposit accounts remain fully funded. Those new dollars eventually make their way into the economy. The bailouts are not meant merely for lending — they also serve to ensure that everybody’s checks don’t bounce.

    The more defaults happen, and the more the toxic assets are acounted for and written off (or sold to the Fed), the more new dollars will come into the economy via our everyday transactions.

    An increase in prices is not inflation; it is a symptom of inflation — and currently, that symptom is being masked by the overall drop in market demand. Inflation is an increase in the money supply and the concomitant devaluation of the currency unit — and that is happening wholesale. This is because the dollars being lost in defaults represent real wealth being lost and/or sequestered via misallocation (e.g. all the labor and materials now frozen in unoccupied houses) and lowered economic productivity, while the *new* dollars replacing them are not the result of any actual wealth generation at all — they come from a printing press.

    More dollars, fewer goods = inflation.

    So even if borrowing remains slack, the inflation will happen anyway — we’ll start to see it when the deleveraging, defaults and writeoffs finally peter out, as people draw down their savings — which will consist largely of newly printed money. It’s baked in no matter what.

  10. CJ says:

    Very good short analysis. It`s amazing how many people still seem to think that this will all be over in six months or so, in spite of banks failing left and right and all the other financial follies we`re seeing daily. I quibble only with this:

    “…when all of that overpriced real estate enters foreclosure and they have to mark a $500,000 California mortgage down to the $300,000 the house will fetch on today’s market.”

    May I suggest that houses in CA that were supposedly “worth” 500k at the peak in 2005-2006 have already fallen below 300k and the bottom is nowhere near. The median price of CA residential RE fell 38% in the 12 months ending December 2008. A year or two from now that 500k house will be lucky to fetch 200k.

  11. KD says:

    What folks haven’t considered is how the coming inflation will play out.

    Here’s how it plays out: In order to fight this inflation, the Fed must raise interest rates.

    Roughly 35% of mortgages are adjustable. When the Fed raises interest rates, poof … your house note just went up even though your pay did not.

    As the Fed increases interest rates to fight raging inflation, more and more people will be priced out of their own homes and those homes will fall into foreclosure.

    Anyone see a vicious cycle here?

    The Fed, by allowing the sale of adjustable rate mortgages to start with, created the problem. It was trying to eliminate the risk of interest rate moves.

    But there will always be risk when lending money. You cannot violate that law. Any attempt to violate this law will result in comically tragic results.

    As we are seeing today.

  12. Mark in Texas says:

    The only reason we are seeing that spike on the charts is because the money supply statistics don’t reflect all those exotic mortgage based derivatives that have a cumulative face value of several trillion dollars and a market value of zero.

    In actual fact, inflation is going to be the only way out of this mess. Too many people are upside down on their houses for the banking industry to survive otherwise. Since people have to live somewhere, most people who’s mortgages are more than their house value will continue to make payments as long as they can, but if they lose their jobs or have to move, they will mail their keys to the bank and walk away.

    If the government wants to prevent hyperinflation as things start to recover they can simply declare that things like credit default swaps are illegal and that any contracts that use them are null and void making the value of those derivatives remain zero. That will also make untangling the mortgage mess a lot simpler as several levels of complication are chopped away and will prevent future generations of clever financial professionals from screwing up the economy in this particular way again.

  13. Chris says:

    The rampant printing of money right now is like a farmer spreading fertilizer in January. Nothing comes of it, so they spread another round, and another, and another. When the cycles (and it’s ALL about cycles) bring the next warm economic season, the disaster that is all that fertilizer will explode.

  14. Brian Macker says:

    This is why fractional reserve banking DOESN’T work. Banks loan out money long term that they’ve promised to return to depositors in the short term. That money drives up asset prices that it is used to purchase. Then the money get RE-DEPOSITIED in the banks, and loan it out again.

    If the reserve rate is 50% then that doubles the money supply, if the reserve rate it 4% that makes the money supply jump to twenty five times. The banks then have twenty five times as much short term obligations than they can possibly pay.

    This draw down of reserves and pumping up of loans is what leads to the business cycle. It also distorts interest rates making them lower than they would otherwise be leading to over investment in long term capital goods, and companies like in commodities, housing and internet stocks.

    It also causes a bunch of other problems that I won’t go into. It is essentially a kind of sophisticated pyramid scheme that crumbles when the reserves hit their low point. At that point the rise in asset prices stops and people who were planning on them going up further will not be able to pay back. The banks assets being backed by inflated goods means it starts repossessing goods worth less than it’s loans.

    This whole mechanism is anti-free market because it is based on a fraud. Banks should NOT be able to borrow short term and lend long because it involves signing a series of contracts that they cannot perform on. It should be obvious that you can’t hand people their money back on demand if you’ve lent it out for fifteen years. Of course bank runs will be the result.

    Originally this was against the law but banks convinced the government to make it legal. This resulted in the boom-bust cycle we’ve seen since. Of course more ancient cultures governments found other ways to mess with their money, like debasing there coin, that have similar effects but lets not get into that.

    Our government decided the way to fix the problem was with a central bank, but this only allows the banks to coordinate their reserve draw downs to even lower levels. That is what happened during the roaring twenties, fractional reserve monetary inflation. So the fix only made things worse and resulted in the crash of 1929 and the Great Depression.

    After the 1929 crash the government decided to steal the gold from everyone and go to a new monetary system, wherein it only allowed gold to be traded to other countries. This new system failed by the time Nixon was in power and he went of gold completely, but gold was never the problem. It was fractional reserve.

    Now we were on a new monetary system. Fractional Reserve backed by Fiat money. Fiat money meaning that an unlimited supply of money could be printed up because they were not notes against any commodity money. It is essentially like a Ponzi scheme with money. Instead of printing up more stock based on vapor it is money that is printed up.

    So the “cure” to a cyclic monetary pyramid scheme was to underpin that scheme with a ponzi scheme. The idea being that when the pyramid scheme starts to collapse as they tend to do then what we will do is spin up the ponzi scheme to keep money flowing.

    This is, of course a ridiculous scheme. It allowed the pyramid scheme to be pumped up over and over. It’s now collapsing. So they are pumping again.

    Brian Macker´s last blog post..Robert Lucas’s Strange Faith in Bernanke

  15. Mark Warda says:

    All the analysis I’ve seen only looks at the money supply provided by government. But back when Sears had it’s own credit card, didn’t they create money when they let someone buy a TV with no money down? And if I sell a free and clear house and hold the paper, doesn’t that create money? And when Google issues a billion shares of stock and sells them for $1 each and the next week everyone’s shares are worth $100 each, doesn’t that create money? Why is only paper currency figured in the money supply? Or am I misunderstanding something?

  16. LarryD says:

    Mark, that’s why there are three metrics for the money supply M1, M2, and M3.


    These measures correspond to three definitions of money that the Federal Reserve uses: M1, a narrow measure of money’s function as a medium of exchange; M2, a broader measure that also reflects money’s function as a store of value; and M3, a still broader measure that covers items that many regard as close substitutes for money.

  17. PaulT says:


    Inflation hedges: TBT (Ultrashort Treasury ETF), DBC (commodities futures ETF). I am long DBC.

  18. Derek says:

    KD ~ The US is practically the only country in the world where adjustable rate mortgages are not the norm. Fixed mortgages are the unique around the world, the mortgage terms are not the problem.

  19. LS says:

    Everyone seems to be convinced that inflation hasn’t hit us yet…that we’re looking at deflation. I’m no economist, but still I’m not so sure.

    A few months ago, a half gallon of ice cream became a quart and a half at the same price. That’s a 33% price increase. A 6 ounce can of tuna suddenly became a 5 ounce can of tuna. That’s a 20% increase. Is everyone so sure there’s no inflation?

  20. I enjoy the site. i made my comments on my site earlier this year. If anyone is interested please look at http://derivativemusings.blogspot.com/2009/01/ouroboros-deflation-and-2008.html
    don’t want to load you with one page comment

  21. Brian Macker says:


    During a normal hard money fractional reserve boom-bust cycle it is commodities that rise in price fastest. Consumer goods tend not to go up that much in the first place.

    When you add fiat money on top of that it tips the cyclic curve up. So while commodity prices (and housing prices) drop enough to compensate for fiat monetary inflation (and resulting price increases), the same is not true for consumer goods. So they go up.

    Brian Macker´s last blog post..Robert Lucas’s Strange Faith in Bernanke

  22. Pingback: News you gotta have to end your week - 1/30/09 | Michael Gracie