The Continuing Puzzle of the Hyperinflation that Hasn’t Occurred
By Robert Higgs | Thursday June 23, 2011 at 1:49 PM PDT
Since late December 2008, the bank prime lending rate — the interest rate banks charge their best corporate customers — has remained steady at 3.25 percent.
Meanwhile, during the same period, the excess reserves that commercial banks hold at the Fed have increased from $2 billion in August 2008 to $1,513 billion in May 2011.
Ordinarily, one would have expected this development to produce hyperinflation of the general price level. However, the price level has increased quite moderately, and for a while many analysts warned that deflation was the greater risk. Despite a slight increase in the price level’s rate of growth in recent months, the index of prices paid by all urban consumers has increased by only about 6 percent in the three and a half years since the beginning of 2008. Not only has hyperinflation failed to appear; even garden-variety inflation of prices in general has been extremely low by the standard of recent decades.
The preceding combination of events poses a great challenge to economic analysts. How can we explain that the fantastically enormous explosion of bank reserves has not given rise to bank lending that would greatly expand the money stock and thereby drive up prices in general?
The most obvious answer, of course, is that the banks are simply sitting on the reserves, rather than lending them to customers. And why are they doing so? The usual answer is that since late 2008, the Fed has paid the banks a rate of interest on their reserves at the Fed. This interest rate has recently been in the range 0-0.25 percent. Although this is not nothing, it verges very closely on nothing. And if one notes that the purchasing power of money has fallen at least a bit, it is clear that the banks are realizing a negative real rate of return on their holdings of excess reserves at the Fed.
Moreover, they are doing so notwithstanding that they appear to have the option of lending at 3.25 percent to their best corporate customers and at higher rates to their less creditworthy customers. Why are they forgoing the opportunity to earn huge sums by switching out of excess reserves at the Fed into commercial loans and investments? The answer would seem to be that that are so frightened of the risk associated even with loans to their best customers that they are loath to lend. After some volatility up and down and then up again between the summer of 2008 and early 2010, total loans and investments of all commercial banks have settled for more than a year at a level only about 2 percent greater than their level at the beginning of 2008. This increase of about $200 billion amounts to only a small fraction, about 13 percent, of the increase in their excess-reserve balance at the Fed during the same period.
In these circumstances, some economists have taken to arguing that excess reserves no long constitute “high-powered money,” that they no longer belong to the monetary base, and therefore they have not proved to be the fuel for hyperinflation that nearly all economists would have expected them to be prior to the past four years of anomalous experience.
I am not convinced. First, I am not convinced that these gigantic sums will not, sooner or later, still become the fuel for hyperinflation, or at least for a greatly accelerating rate of general price inflation, which economists expected they would be before the recent recession and all of the government’s and the Fed’s extraordinary responses to it occurred. Second, I am not convinced that the banks will remain content forever with earning a negative real rate of return on their holdings of $1.5 trillion in excess reserves now languishing at the Fed. If they were to realize only the difference between the rate the Fed is paying them and the rate they would earn by lending these funds exclusively to prime customers — an increase of 3 percent on their return — they would gain an additional $45 billion in income. That’s a great deal of potential income to leave lying on the table, and it might be even greater if we factored in the additional income they might earn by lending to less-than-prime customers at greater rates. I understand, of course, that banks are seeking to repair their damaged balance sheets, in light of their recent debacle in real-estate-related investments of various sorts and in conformity with the new Basel requirements for increased bank capitalization. Still, I am not convinced that these consideration can account fully for the very curious conditions now existing in the banking industry.
Of course, my lack of conviction in the new wisdom may be groundless. This time, everything really may be different. But as an economic historian, as well as an economist well behind the cutting edge of his profession, I am not ready to latch onto this latest “this time it’s different” explanation, at least not until a long time has passed and my skepticism has been proved baseless by long-sustained counter experience. At the moment, the conjunction of recent macroeconomic events still seems to me to pose a great puzzle.
Perhaps a part of the answer relates to the regime uncertainty about which I have written from time to time during the past three years, harkening back to my earlier writing about its significance during the second half of the 1930s, during the so-called Second New Deal. It would hardly be astonishing if such worries were now contributing to the extreme risk aversion banks are manifesting. Moreover, perhaps for the same reason, potential borrowers are not exactly clamoring for loans, and indeed many corporations are sitting on huge cash hoards of their own. Interesting times, indeed.
Tags: Business, Economics, Federal Reserve, Inflation, Money and Banking 
“The answer would seem to be that that are so frightened of the risk associated even with loans to their best customers that they are loath to lend”
If this is the case, then why doesn’t this caution manifest itself as higher interest rates?
Something does seem weird here. Do you think it’s possible that the banks are being pressured in some way to hold on to those reserves?
Bretigne | Jun 23, 2011 | Reply
Prof Higgs,
Reserves have not been a constraint on bank lending for some decades. (The Fed effectively removed any residual binding reserve requirements in 1995). I agree with the piece below that lending is constrained by capital and by customer demand:-
http://lanle.wordpress.com/2009/12/31/the-truth-about-all-those-excess-reserves/
I do agree that we are likely to see a pickup in broad inflation over time. Headline CPI has already based; core CPI has been held down by the temporary impact of weak rents (housing constitutes 40% of core). The apartment vacancy rate was 12% at the peak; it has a 9 handle now and should be 5.5% odd by next year. So we can expect core to be 1.8% yoy by year end (per Deutsche).
Job growth has been weak because of an initial productivity surge and because gas prices have been high (which depressed consumer confidence). As gasoline prices continue to come down, we should see consumer spending pick up, house prices stabilize and hiring pick up. A pickup in hiring is a prerequisite for wage growth to pick up (which is needed before inflation can be sustained).
Also one should note that the change in broad money velocity is related to the change in hiring. So we should see credit growth turn up with jobs.
Here is a link to the piece about reserves
http://lanle.wordpress.com/2009/12/31/the-truth-about-all-those-excess-reserves/
Cantillonblog | Jun 23, 2011 | Reply
Wrt the prospect for a pickup in credit growth, one should note that present popular perception of house price performance is distorted, or at least based on incomplete information. The Case Shiller reported numbers do not distinguish between voluntary sales and foreclosures. Foreclosures are in worse condition, tend to be located in different areas and to shift them requires some premium given the substantial supply vs capacity of buyers to bear inventory. Foreclosure prices have continued to fall. Voluntary sale prices have actually been stable, but the rising share of foreclosures in total sales has the effect of pushing down the aggregate index even more than would be the case if it just had to reflect the falling foreclosure sale prices. Given that rental yields are high, that rents have put in a low and will rise substantially from here (due to clearing of the overbuilding) and amidst horrendous sentiment (always wrong at turning points) I would expect we are not very far from a major low in US housing prices. Obviously as the labour market continues to improve at a time when gas prices are falling, rising real incomes will help the overall picture.
Policy has been terrible for the past century. But it would be a mistake for free-market oriented economists to fall into the trap of always being negative about economic prospects (not that I suggest you are guilty of this, but it clearly is true of some of our friends). Even if things would be better under a different policy regime, there is still an economic cycle and a cycle in asset prices. Things do eventually improve.
Wrt the possibility for hyperinflation, I humbly suggest that you might be looking in the wrong continent. The popular perception is that the ECB retains prudent Buba strands in its DNA. That may have been the case until recently, but it is an open question as to how the monstrous sovereign-bank debt problem will be resolved. It is not clear there will in the end be any solution for financing the periphery beyond money-printing. There certainly is a diminishing appetite on the part of the core to undertake further real transfers.
Cantillonblog | Jun 23, 2011 | Reply
AN INSANE TIME TO EXPERIMENT WITH PAYING INTEREST ON EXCESS RESERVES!
Pete McAlpine | Jun 23, 2011 | Reply
“CREDIT WORTHY” CORPORATE CUSTOMERS DON’T NEED TO BORROW MONEY! Perhaps moronic bank regulators closing the barn door after the horses have excaped may be the problem.
Pete McAlpine | Jun 23, 2011 | Reply
Seems to me bank executives can lay-off all their loan department personnell and just collect interest from the FED: no cost no risk, just nice bonuses for themselves.
Pete McAlpine | Jun 23, 2011 | Reply
Look at that stupid interest rate bump imposed in 2004-2005 by the FED for NO APPARENT REASON except to CRUSH THE ECONOMY! What jerks!
Pete McAlpine | Jun 23, 2011 | Reply
Even if these reserves are lent out, I don’t see the possibility for hyperinflation. I think that the Federal Reserve will just as quickly precipitate some type of credit contraction in the event of very high inflation.
The only realistic scenario for hyperinflation that I can see unfold is one in which the Federal Reserve is tied to monetizing government debt (and government continues to spend). I don’t know how the government can “force” the Federal Reserve to continue to buy debt in the advent of high inflation, but if it is ever possible then this is the only real way I foresee hyperinflation.
I can’t speak for all historical examples of hyperinflation, but it seems to me that most (if not all) are characterized by similar factors. High public debt, a central bank willing to monetize that debt, and continued government spending.
Jonathan M. F. Catalán | Jun 23, 2011 | Reply
Well, the lack of price inflation in consumer goods makes sense. The excess reserves are the key, of course, and they make sense for now.
At the great risk of oversimplification, if Congress and the Executive branch weren’t so busy adding new programs, extending unemployment benefits, and adding costly new regulations, then we would probably be experiencing a lot more inflation right now. But who is going to borrow and who is going to lend in this environment?
Brent | Jun 23, 2011 | Reply
Jonathan,
Your comment presumes that in the event that the banks begin to lend substantial sums of their current excess reserves, creating pressures for general price inflation, the Fed will be able to offset this action. Bernanke has spoken about this possibility, emphasizing that the Fed has “the tools” to carry out such an offsetting policy. However, because the Fed has never had to deal with a problem of similar magnitude, it is not clear that the Fed actions would succeed, if taken at all.
Moreover, it is clear that the main tool Bernanke has in mind is raising the rate the Fed pays the banks for their excess reserves held at the Fed. Employment of this option on a substantial scale, however, means allowing interest rates across the board to rise, and thereby threatening any general economic recovery taking place at the time. Such a move by the Fed would certainly elicit great political pressure by the administration and Congress to overturn it, especially when it is almost certain that the Fed will need to be very accommodative in its policies in order to assist the huge borrowing the Treasury will be doing in the future for as far as the eye can see.
So, your comment about this last aspect of the problem is highly germane. QE2 was designed to have the Fed directly fund the Treasury’s deficit — in effect, it was a policy no different from the Treasury’s printing its own money and spending it, as it did during the Civil War with its “greenbacks.” In the present circumstances, it got away with this accommodation without sparking a large, immediate acceleration of the general price level. Later, when conditions have improved somewhat, however, it may not be able to get away with such accommodation without permitting both greater interest rates and higher rates of general price inflation.
In sum, your comment seems to be more complacent about the risk of substantially accelerating general price inflation than the present facts, placed in historical perspective, warrant. Perhaps Bernanke’s view will prove more perceptive than mine, but I must say that for several years now, he has been wrong repeatedly about nearly everything of any consequence, so I have little confidence in his true grasp of what is happening and what the Fed can and should do about it.
Robert Higgs | Jun 24, 2011 | Reply
If hyperinflation comes it won’t come by the traditional lending mechanism. Right now the American consumer is debt constrained /not/ interest rate constrained. When the banks start directly investing in hard assets and commodities, then is when inflation will skyrocket.
Doc Merlin | Jun 24, 2011 | Reply
The simplest explanation for the lack of lending is a lack of borrowers.
Regime uncertainty makes borrowers shy; optional borrowing is deferred. This is the same reason housing sales are not up after the drop in prices and the lowering of interest rates: Nobody who has money believes they can profit, and the rest don’t have money enough to risk buying.
Regime uncertainty may be the second most-dangerous thing to an economy, after inflation...
Mac McCarthy | Jun 24, 2011 | Reply
“The answer would seem to be that that are so frightened of the risk associated even with loans to their best customers that they are loath to lend.”
I think there is still a lot of mortgage related risk in the pipeline. I think that money will start to thaw when you start seeing mortgage delinquency rates go down. In Q4 of 2010 8.2 percent of mortgages were delinquent. Many of these are under water and will likely cause those reserves to take a hit if they reach foreclosure. Jobs are not coming back as they were predicted. Once we see jobs coming back and mortgage delinquency rates drop back to historically normal levels, that cash will begin to thaw and trickle into the markets.
So I would watch unemployment (indicator of future delinquency rate) and delinquency rate (indicator of future foreclosure rate) along with home prices (indicator of how much of a “hit” a foreclosure would cause on the lender’s reserves).
This article provides about the most recent information I have.
There are some signs things might be starting to firm up, but there are still a lot of mortgages out there that are in trouble and under water. If I were a lender with that much at risk of being lost, I would keep a lot of reserve too.
And this doesn’t even take commercial real estate into account.
George B | Jun 25, 2011 | Reply
I agree with your analysis and the need for caution. The term that I have heard with regard to the present relatively low level of inflation is the low “velocity of money.” This is caused as much by the banks’ reluctance to lend to any but the most creditworthy (keep in mind that banks still have large amounts of bad debt on their books) as the reluctance of people and companies to borrow under an administration that is profoundly anti-free enterprise. This administration wishes to direct money to companies and industries it favors, essentially creating a government-directed economy. That does not create an exuberant economy.
If there is a change of administration after 2012 and the regulatory state is relaxed, the velocity of money will increase substantially which could create a serious problem for the next administration.
Moneyrunner | Jun 25, 2011 | Reply
““CREDIT WORTHY” CORPORATE CUSTOMERS DON’T NEED TO BORROW MONEY!”
And why is that? Because in a slack economy there are few opportunities that require more funds than the corp can generate.
When opportunity rises faster than internal funds generation borrowers will be asking for money.
Which is to say our current problem is really an invention problem. We have exhausted the low hanging fruit from automation. We are waiting for the next big thing.
M. Simon | Jun 25, 2011 | Reply
Anyone who shops for groceries will tell you the inflation is there. It’s hidden in the decreasing packaging sizes. Ice cream used to come in quart containers. Not any more. Bagged ground coffee used to be sold in greater amounts than the 12-ounce bags that are in my fridge.
There’s part of the answer, I believe. Some products can’t hide their increases, such as milk (a gallon has to be a gallon) and meats (always priced by the pound). And as anyone who has eaten Ben & Jerrys can tell you, they’ve diluted the amount of cream in their product. Inflation by using cheaper ingredients.
Bill Peschel | Jun 25, 2011 | Reply
I would agree with the “lack of demand” theory. What little growth in cap ex demand that exists today can usually be accommodated with existing cash flows. Demographics may be playing significant role here. An aging population is not a consuming population. Tack on that we have built most of the houses and commercial structures that we will need for the years to come.
I also would look at the bank reserve requirements. While they are not required to mark to market, they certainly know internally what effect mark to market would have on their reserves. This would discourage term loans when they know that cash may need to be called in on short notice.
Imapopulistnow | Jun 25, 2011 | Reply
With all due respect, I do wish you and others would quit using the phrase “regime uncertainty” and its cognates. There is no uncertainty whatever.
The Fed’s interest rate on reserves is minuscule but is mostly not zero. The absolute certainty that any profits realized from lending will be seized under some pretext, along with gleeful declarations that see, you were wrong, there really is money we can grab for social programs! means that there is no possibility of actually earning; indeed the most likely result in the medium term, and perhaps even the short, is a net loss accompanied by further indignant declarations of how villainous the “banksters” are. The prudent thing to do is therefore nothing.
Regards,
Ric
Ric Locke | Jun 25, 2011 | Reply
It seems to me that inflation has remained relatively low because the Fed has basically been increasing the quantity of money while velocity has fallen in equal measure. Therefore the money supply has not grown.
The big problem this situation has created is that as soon as real growth starts and velocity picks up, the money supply will bloom and inflation will kick in. This in turn will choke off growth. The return of stagflation. And this time, if the fed tries to use higher interest rates to choke off inflation, debt-servicing costs will implode the budget.
The other worry is that the Fed won’t be able to find enough buyers of American debt, and will be forced to buy up the debt itself to stave off a panic. Look for signs of a QE3 if the next few treasury auctions are weak.
Dan H. | Jun 25, 2011 | Reply
Are the banks not using those funds to buy government bonds?
astonerii | Jun 25, 2011 | Reply
Is this a Catch-22? Presuming the regime is changed, Obama loses in 2012 and a chastened Republican Party is returned to power, will this initiate a hyper-inflation? Will Bernanke then slam on the brakes, initiating a major recession? Will the new regime therefore be discredited, leading ultimately to a return of an Obama-like regime on steroids? This is a cycle I don’t want to live through in order to test the Higgs’s hypothesis. Will the elimination of the Fed be the central issue of the 2012 election? Ron Paul not withstanding, I doubt it.
MERLIN | Jun 25, 2011 | Reply
“The answer would seem to be that that are so frightened of the risk associated even with loans to their best customers that they are loath to lend.”
Perhaps it has been so long since these institutions had to actually monetize their own risk that they have forgotten how, and are frightened to try. The American taxpayer is in no mood to bail them out again.
But TARP showed them that if they wait long enough, the Feds will throw guarantees at them. If this Administration gets desperate enough, it might just start doing that. Then the money will pour out; then we will see the long-overdue inflation that QE1 and QE2 have built.
I give it another 15 months.
Steve S | Jun 25, 2011 | Reply
It’s never just one thing; it’s usually a combination on many.
One reason I believe that the banks are sitting on excess is that businesses, especially small businesses, are being cautious in their expansion plans — fear of runaway overhead through mandated medical insurance subsidies, fear of looming higher tax rates (see Geithner’s comment to Congress last week) and fear of higher regulation strangling new business investment. And those are just three reasons off the top of my head.
So if banks are sitting on surpluses, I think that the reason is twofold: both their own timidity AND the lack of demand from the private sector.
Kim du Toit | Jun 25, 2011 | Reply
To whom are the banks supposed to loan money? Companies are sitting on giant cash reserves... It’s what now, just short of 2 trillions?
poul | Jun 25, 2011 | Reply
Consumers won’t take steps to protect themselves from inflation until they feel the inflation. As it is, they fear the effects of the Great Recession more than they fear a burst of inflation. When a quarter of homeowners are under water on their mortgages, they’re not eager to borrow more money to buy houses even at post-crash prices and historically low mortgage rates. They’re right. With a national vacancy rate of 11.4% for single family houses, we have a great deal of inventory to soak up before the properties will appreciate in price. While going into debt before an inflation is financially wise if you can repay with inflated money, that only works if you actually have a job and expect your income to rise. One in eleven American workers doesn’t have a job and many more have seen their incomes stagnate. There will be little demand for inflation-protection measures until the consumers fear inflation as much as they fear the recession they’ve been through.
Jack Olson | Jun 25, 2011 | Reply
The devil may be that the reserve increases from QE2 seems to have landed in foreign banks.
ZeroHedge posted on it about 2 weeks ago and has a follow up with a link to the original. The numbers out of the fed seem clear—the excess reserves are sitting in domestic branches of foreign banks with little change in the reserves of domestic banks.
Take a look.
Adam Sullivan | Jun 25, 2011 | Reply
Kinda Sorta – check into POMO dealers. The Fed is buying US debt via dealers who get a commission. That is where the real money is – getting paid by the government too sell it a product that the government furnishes. That was how QE2 was largely executed – it “printed money” while giving banks profits to help their income statements / balance sheets.
Adam Sullivan | Jun 25, 2011 | Reply
BTW – one way to pressure banks to lend is to change laws so that their non-lending activities aren’t so profitable. If banks serve the function in the economy to store money and lend it, then a quick perusal of their sources of income will show that lending isn’t what they have incentive to do. Not when the trade desk is on fire and quants provide new, “can’t lose”* trades <= (*except when the whole system fails like in 2008.)
Adam Sullivan | Jun 25, 2011 | Reply
Housing prices hyperinflated. However, instead of naming it “hyperinflation” it was called a “bubble.” Oil prices hyperinflated for a bit. Again, it was called a “bubble.”
After the inflation of housing and oil, both went into deflationary collapse.
My point is that perhaps you’re looking in the wrong place for hyperinflation. It’s already occurred.
Blake | Jun 25, 2011 | Reply
The reason they are holding it is because of lack of demand. Large companies don’t need it as they are sitting on their own significant funds and small companies are too afraid that the demand for their products just is not enough to sustain borrowing at any rate.
George | Jun 25, 2011 | Reply
Have you considered the reason why hyper inflation hasn’t appeared yet is due to the 1. $1.4 trillion lost by the financial system from defaulted mortgages? 2. the massive exposure of China and Japan to US debt.
If you merely replace the lost $1.4 trillion in loans with printed money the aggregate value is still the same. The money the banks lost was replaced by the Fed via printed money washed through the banks via ultra low interest loans and then that money is loaned to the US government in the purchase of bonds. The banks are making back their money on the spread using the Fed loan counted as part of their reserve requirement. In other words a money laundering operation.
Mitigating the whole situation is the large exposure of foreigners to US debt instruments. Any attempt by China and Japan to rush for the exits puts their net worth at risk via a precipitous devaluation. In other words, we have a gun to their heads. The only way they can unwind their position without losing most of its value is to gradually reduce it by letting the bond instruments mature and then purchase anything like oil that is still denominated in US dollars to repatriate their investments.
Once the Chinese figure out how to repatriate their money without losing most of it they will quickly exit leaving someone holding the bag. They just exited the T-bill market, who is buying them other than the Fed?
dscott | Jun 25, 2011 | Reply
No hyperinflation – yet.
But plain old serious inflation? Go try and buy a half gallon of ice cream. Hint; you’ll find a bunch of 1.5 quart containers instead.
sigh | Jun 25, 2011 | Reply
We are not experiencing inflation, we are experiencing USD DEVALUATION. Look at the St. Louis Adjusted Monetary Base (BASE) chart produced by the Federal Reserve Bank of St. Louis for the why. The look at a USD/CHF chart from say 2001 to present (sorry, I tried to attach mine without success) and you will see a decline from 1.82CHF to the dollar in July 2001 to .83 CHF to the dollar today. A serious decline in USD purchasing power, but not technically inflation. As a USD based consumer I darn sure feel it, regardless of what it’s called.
One assumes that the banks are hedging their USD reserves, or else they are idiots.
John Pennell | Jun 25, 2011 | Reply
Supply and demand.
Lots of cash available, but few borrowers. Inflation should be through the roof, but there is downward pressure due to lack of demand versus supply.
Another downward pressure is the housing market. It is worse than during the Great Depression. Prices are still falling, because of low demand. Not enough steadily-employed people.
Also, the CPI is BS, anyway. The rioting in the ME is because food prices are through the roof. It’s not just there, but here too. I can no longer afford certain foods. I have had to cut them from my budget. The price has gone up too much.
The high inflation will take effect after the next election. When they roll back regulations, when they provide a stable business environment, the economy will take off. When it does, the cash will flow... in enormous quantities.
Businesses will spend. People will be hired. Stability will return. Folks will then buy houses. The downward pressure will be gone. Then we have to pay the piper.
Just like during ’81 & ’82, inflation will rise for a time. Eventually, prices will subside, but the price must be paid. There is no getting away from it, unless we stay at this pathetic level of the economy.
Marc Malone | Jun 25, 2011 | Reply
“there are many factors...” said someone. I don’t see a mention of demographics. An aging population means less demand for business loans for start-ups, etc.
Richard Hill | Jun 25, 2011 | Reply
Banks have steadily continued to cut lines of credit. This in turn causes credit scores to drop which make businesses/consumers less credit worthy.
I had $200k in unsecured lines of credit in 2008. During the intervening 3 years my total debt has dropped $250k – never been late or missed a payment. Every time I make a paydown, the banks reduce my credit limit. When I pay off a LOC, they cancel it.
When there is no supply of money, I can’t buy things at higher prices, so pressure is on sellers to reduce price.
Paul | Jun 25, 2011 | Reply
I’m not much of a believer in the power of the velocity of money, but I do agree that the next president, assuming Obama loses the election to a more business-friendly Republican, will face a situation similar to that of Ronald Reagan.
Reagan, educated in economics before Keynesianism, understood the dangers of inflation and stood by silently while Paul Volcker threw the country into a violent, deflationary shock. The Democrats, shrieked that Reagan’s tax cuts were the cause (?), but Reagan kept silent and the inflation was tamed.
I don’t envy and, actually, can’t imagine a Republican who could stoically endure what surely must come again.
Craig | Jun 25, 2011 | Reply
This is going to sound kind of odd, but I think stepping back from specific numbers and looking at the macro-environment possibly show that there is a circumstance in which 2 – 3% inflation actually is hyperinflation–well, higher inflation than a simple 2 – 3%.
The circumstance? When we are in a deflationary period. In that case, the deflation factor has to be added in to the inflation.
A lot of posts here have noted various factors that support this possibility: the cheapening of the US dollar, bringing for example, bafflingly high commodity prices; the resiliency of the stock market, resolutely refusing to drop; the continuing excruciating default rate which should have been a quick massive plunge; corporations and banks holding cash in low yield assets...I’ll stop.
Bernanke is, as I understand it, terrified of the Depression blunder of a shrunken money supply, but has little control over fiscal and economic policy. He is pumping in money to keep the economy treading water.
A return–I hope–to economic and fiscal policies with a proven record of expansion in 2013 should leave Bernanke with the problem of sopping up all that bank money. Perhaps he is “encouraging” them to keep it where it is in preparation for that time.
Pure speculation, but I think that if everything indicates a higher inflation rate than we seem to be observing, then part of the answer may be the deflationary factor is discounted.
Jeff Z | Jun 25, 2011 | Reply
Somewhere I read that there was two trillion or so dollars on the sidelines from the stock market due to uncertainty created by the current administration. Is this true, and if so, is any part of that in the reserves this post is talking about? If not, that’s a lot of money coming out when the uncertainty disappears. Makes one think of silver and gold...
Jeff | Jun 25, 2011 | Reply
I’ve hired a general contractor to do some work on my home this summer. We’re getting a new roof, doing some concrete work, maybe some other things. He told me last week that three years ago he had a $2 million line of credit. Now he’s just working job-to-job. He has to have 50% up front to start a shingling job because he hasn’t got enough float to buy shingles.
In the early 30′s my grandfather couldn’t get the bank to loan him $120. He couldn’t get his father to loan it to him, either. Great-grandma sneaked it to him without telling his dad, and by salvaging building materials he made enough to pay her back and build the house he lived in for the next 70 years.
He used to tell me “Everything was cheap in the 30′s. You could buy a dozen eggs for a nickel! But nobody HAD a nickel!”
Jon | Jun 25, 2011 | Reply
I submit that you’re not taking into account that the dollar is still the world’s currency so there is more flex ... both good and bad. Fortunately for the dollar, and us, the euro has its own problems with the debt crisis. If it weren’t for that, people would already be bailing for the euro which would put us into a hyper-inflation situation.
LoboSolo | Jun 26, 2011 | Reply
Are banks hedging against another collapse scenario, one without a bailout? Are they self-insuring their depositors and themselves?
Mike Mahoney | Jun 26, 2011 | Reply
With regard to any “commodity” other than money, we would all quickly identify lack of demand as the answer. We would never suggest that producers are unwilling to sell their product.
Why is money different? The obvious answer is: “it is not different at all.” Demand for money is lacking because potential borrowers lack confidence that they can use the money profitably. The lack of confidence comes from the uncertainty produced by hyper-interference in the economy by the U.S. government (and in many cases lower levels of government also)
Owen | Jun 26, 2011 | Reply
Point of information:
“the interest rate banks charge their best corporate customers”
Are these “best corporate customers” other banks or firms like P&G?
Bob Lince | Jun 26, 2011 | Reply
Some other variables:
How does a global currency affect monetary theory on the national stage? Unlike say, Canada, the USA can export its inflation across the planet (which also arguably renders quantitative easing policy much less effective) if I understand correctly.
The banks are still bankrupt, and there is relatively little demand for loans. So neither side of the transaction is excited.
Jim | Jun 26, 2011 | Reply
You managed to catch Scott Sumner‘s attention. I wish he wasn’t on semi-vacation and could respond more thoroughly.
TGGP | Jun 26, 2011 | Reply
Couldn’t this be in anticipation of the raising of capital requirements by Basel III/Dodd-Frank?
Alice | Jun 27, 2011 | Reply
Maybe this was commented on already, but I wonder if there are really much excess reserves for banks still having exposure to significant housing loans and related financial instruments.
If housing prices have another 10-20% to fall in various markets, then more loans are underwater and financial portfolios based on them will lose value. If banks are forced to revalue these loans, much of their apparent reserves will vanish.
I guess one could check by looking for correlations between “excess” reserves and housing loan exposure.
Greg Rehmke | Jun 27, 2011 | Reply
Professor Higgs:
Here is the problem with your analysis.
Subhi Andrews | Jun 30, 2011 | Reply
All of the foregoing commentaries suffer from analysis paralysis....by focusing on the technical aspects of Fed actions and bank lending decisions...all the leftovers from Keynesian thinking...that everything in economics/human action can be quantified...they simply can not..try looking at what has happened to individuals, households and businesses since the election of Obama (one whose economic paradigm is one of winners and losers, rich vs. non-rich and wealth redistribution not creation) UNCERTAINTY, the mortgage/financial collapse UNCERTAINTY, government takeovers of major sectors of the economy..autos, finance, healthcare UNCERTAINTY, the rise of some in the middle class to say STOP IT via the tea party victories in 2010 UNCERTAINTY...the logjam now on the deficit/debt ceiling and what the outcome might be UNCERTAINTY...what’s coming next has caused any decision maker with half a brain to hunker down, retrench, go to gold and prepare for the next shock of UNCERTAINTY...with widespread UNCERTAINTY there comes huge risks of economic losses if one is not conservative and judicious in economic decision-making...go back and read the work of the distinguished economist Frank Knight...his book Risk, Uncertainty and Profit and help you grasp these issues.
john hosemann | Jul 5, 2011 | Reply
Bob Lince – Prime rate = best corporate customers ie nonfinancial firms like IBM, P&G etc. The main virtue of this rate is that the series goes back a long way (even if the practical applicability of this rate in modern conditions is much less than it used to be)
Cantillonblog | Jul 10, 2011 | Reply
Actually, Volker was Carter’s choice for Fed chief, Reagan merely re-appointed him. The de-regulation of the trcuking/airline industries also were enacted by the Carter admin. What Reagan SHOULD be given credit for, is tripling the national debt while in office and ushering in the modern era of deficit spending.
Neil | Jul 10, 2011 | Reply
with rising input costs starting to cut into margins, what are investors borrowing to invest in? it seems most borrowing is simply leveraged speculation, not investment in extending the capital structure or enlarging the economy’s output. given the political/macro-situation, these are certainly risky loans. before banks could expect gov’t to absorb these risks for them if they went bad. but perhaps even the banks realize the gov’t is (at least potentially) tapped out at this point.
Robert | Jul 11, 2011 | Reply
That 3.25% prime rate is mainly for home equity and credit cards. If you’re concerned about corporate borrowing, perhaps a better rate is commercial paper rates. AA and A2/P2 (which really only reflect extra risk) nonfinancial yields are not nearly that enticing.
http://www.federalreserve.gov/releases/cp/
John Hall | Jul 26, 2011 | Reply