The Market Oracle
This is Not the 1930’s Depression, Which Means High Inflation to Come
written by Michael Pollaro, retired Investment Banking professional
May 07, 2009 - 01:38 PM
Many comparisons have been made between today’s financial and economic crisis and the Great Depression, none more than the specter of deflation. Well, contrary to what happened during the Great Depression and contrary to the deflationary forecasts of government leaders, central bankers and economists, deflation, while always possible, is, in this man’s opinion, highly unlikely. Why’s that? Because the monetary and political framework of today is nothing like that of the early 1930’s. In fact, it’s nothing like anything seen, ever. Quite simply, today’s monetary and political framework is built for inflation, as much inflation as the government, the Federal Reserve and their banking partners want. And inflation, and a whole lot of it, is exactly what we are about to get.
Today’s Monetary and Political Framework, Truly Different this Time
Now, what is so different about today’s monetary and political framework versus that which existed on the eve of the Great Depression? Simply put, all the checks on inflation, all the deflationary holes in the system that brought on the deflation of the 1930’s have been removed. In so doing, the government, the Federal Reserve and their banking partners have given themselves all the tools necessary to create as much inflation as they like. What we have today is a fiat based monetary system at the discretion of politicians and bankers bent on printing and spending our way to supposed prosperity (not to mention helping a few campaign reelections and banking interests along the way). That is not what we had on the eve of the Great Depression, not even close.
This begs three questions, the answers to which will tell us a lot about the prospects for inflation going forward. Let’s answer these questions one at a time:
1) Why didn’t the banks channel those reserves into loans and investments and what will in fact make them do so?
To answer this question we must first understand what these excess reserves are and what they are not. As was the case in the 1930’s they ARE NOT cash set aside by banks because of, or in fear of bank runs and therefore locked away for years to come. Why would they be, with FDIC insurance and all manner of government and Federal Reserve loans and guarantees readily available to soothe the nerves of depositors and to back-stop bankers? They ARE though a prudent way for banks to park funds while the government and Federal Reserve cleanse bank balance sheets, reflate the economy and pave the way for the pyramiding opportunities to come. Call it inflation in the pipeline, and a whole lot of it too.
And where you say is this next wave of inflation, the one the banks are waiting to pounce on? No one knows for sure where all this is ultimately going, but in this man’s opinion, the next inflation wave is likely to start where it always does - in or around the primary monetary injection point. And this time that’s the government complex and all it touches. Indeed, the spender of last resort, led by Obama, and the printer of last resort, led by Bernanke, are already on the case in unprecedented fashion. Wherever they direct their energies, profit seeking banks, armed with a mountain of reserves, will soon follow.
To the extent the banks do lend or invest, are not these reserves under the control of the Federal Reserve, i.e.; can’t the Federal Reserve withdraw those reserves whenever they deem appropriate, thereby capping inflation?
First, it is not just the size of the reserves that are in question; it’s the composition of the assets behind it. Well over half of the Federal Reserve’s balance sheet is TOXIC – long-dated, and still deteriorating mortgage and consumer claims likely marked at prices well above market clearing rates. Gone are the days when the Federal Reserve’s balance sheet was Treasury IOU’s.
Now, in order to withdraw reserves, the Federal Reserve must sell securities. But, if the Federal Reserve is increasingly being “asked” to fund mounting government spending programs by buying Treasury IOUs, that means the only assets it has for sale is overpriced toxic securities. Under those circumstances, do you think the Federal Reserve might have a hard time reducing its balance sheet and withdrawing reserves? Do you think the market knows it too? The last thing the Federal Reserve will want to do is dump these assets onto the market. The mere mention would cause the prices on these assets to tank and interest rates to surge.
Indeed, there is likely only one buyer for these assets at anywhere near current marks, and that’s our spender of last resort, the government. And if the Federal Reserve does in fact decide to sell these assets to the government (for example for optics), how do you think the government is going to pay for it? By issuing IOU’s to the Federal Reserve in return for money printed out of thin air, that’s how. Conjures up a picture of a dog chasing its tail, doesn’t it.
Second, everything the government and the Federal Reserve are doing today is NOT going to turn the economy around. In fact, it’s almost guaranteed to make things worse. A country can not print and spend its way to prosperity, especially one as distorted as ours, particularly when the government, the bastion of inefficiency and waste, is doing all the heavy lifting. The 1930’s are a case in point. As such, this is hardly an environment that lends itself to a contraction in the Federal Reserve’s balance sheet in the eyes of a Ben Bernanke. That’s for sure.
2) What if the banks in the end don’t lend or invest, or don’t to the full extent of the Federal Reserve’s reserve requirements; does that negate the inflation case?
Let’s start with the undeniable fact that even though banks are stock piling reserves, the money supply is still growing at double digit rates. As Doug Noland chronicled, the government, its agencies and the Federal Reserve have all stepped up and are injecting money directly into the economy. The banks have been bystanders, yet, we inflation at double digit rates.
This then raises an interesting question. With all the new inflation tools at its disposal, maybe the Federal Reserve doesn’t need the banks to inflate, at least to the same extent it has in the past. Think for a minute. Are not Fannie Mae and Freddie Mac lending money to home buyers and is this not being financed by the Federal Reserve, both directly through purchases of their debt and indirectly through monies supplied by the US Treasury? Is not the FDIC bailing out bank depositors, ultimately back-stopped by the Federal Reserve’s printing press? Is not the government spending huge and growing sums of money, increasingly being financed by the Federal Reserve? Yes, yes and yes.
Now consider this. What if the banking system is nationalized, a la Fannie and Freddie? Or like AIG. It could happen, if not in name then in substance. Then the banks will be told what do, wont’ they. Now that’s a scary thought, don’t you think?
A whole lot of inflation is in our future, one way or another.
3) How Big this Inflation Cometh?
Ok, lots of inflation and lots more to come. But how big is this inflation, really?
In his April 3rd Interest Rate Observer , James Grant reported that the combined Federal Reserve and US government response to this economic crisis, defined as the change in the Federal Reserve’s balance sheet plus the US government’s fiscal deficit as a percent of GDP, is some 30% of GDP. To put that number into perspective, that’s 10 times the postwar recession average of 2.9% and 3.5 times the previous record of 8.3% seen in you guessed it, the Great Depression.
The size of today’s government’s reflation efforts truly dwarfs anything we have seen in the past and suggests some truly eye-popping price inflation rates in the future. On that score, it’s interesting to note that the greatest price surge in the post gold standard / FDIC era, one that saw the CPI rocket to 15%, began during the 1973-74 recession with a combined Federal Reserve and government response of a mere 4% of GDP. At today’s 30%, and we are not done yet, one can only imagine the kind of price inflation that awaits us this time around.
Please click HERE to read this entire article... MUST READ in-depth analysis!
This is Not the 1930’s Depression, Which Means High Inflation to Come
written by Michael Pollaro, retired Investment Banking professional
May 07, 2009 - 01:38 PM
Many comparisons have been made between today’s financial and economic crisis and the Great Depression, none more than the specter of deflation. Well, contrary to what happened during the Great Depression and contrary to the deflationary forecasts of government leaders, central bankers and economists, deflation, while always possible, is, in this man’s opinion, highly unlikely. Why’s that? Because the monetary and political framework of today is nothing like that of the early 1930’s. In fact, it’s nothing like anything seen, ever. Quite simply, today’s monetary and political framework is built for inflation, as much inflation as the government, the Federal Reserve and their banking partners want. And inflation, and a whole lot of it, is exactly what we are about to get.
Today’s Monetary and Political Framework, Truly Different this Time
Now, what is so different about today’s monetary and political framework versus that which existed on the eve of the Great Depression? Simply put, all the checks on inflation, all the deflationary holes in the system that brought on the deflation of the 1930’s have been removed. In so doing, the government, the Federal Reserve and their banking partners have given themselves all the tools necessary to create as much inflation as they like. What we have today is a fiat based monetary system at the discretion of politicians and bankers bent on printing and spending our way to supposed prosperity (not to mention helping a few campaign reelections and banking interests along the way). That is not what we had on the eve of the Great Depression, not even close.
This begs three questions, the answers to which will tell us a lot about the prospects for inflation going forward. Let’s answer these questions one at a time:
1) Why didn’t the banks channel those reserves into loans and investments and what will in fact make them do so?
To answer this question we must first understand what these excess reserves are and what they are not. As was the case in the 1930’s they ARE NOT cash set aside by banks because of, or in fear of bank runs and therefore locked away for years to come. Why would they be, with FDIC insurance and all manner of government and Federal Reserve loans and guarantees readily available to soothe the nerves of depositors and to back-stop bankers? They ARE though a prudent way for banks to park funds while the government and Federal Reserve cleanse bank balance sheets, reflate the economy and pave the way for the pyramiding opportunities to come. Call it inflation in the pipeline, and a whole lot of it too.
And where you say is this next wave of inflation, the one the banks are waiting to pounce on? No one knows for sure where all this is ultimately going, but in this man’s opinion, the next inflation wave is likely to start where it always does - in or around the primary monetary injection point. And this time that’s the government complex and all it touches. Indeed, the spender of last resort, led by Obama, and the printer of last resort, led by Bernanke, are already on the case in unprecedented fashion. Wherever they direct their energies, profit seeking banks, armed with a mountain of reserves, will soon follow.
To the extent the banks do lend or invest, are not these reserves under the control of the Federal Reserve, i.e.; can’t the Federal Reserve withdraw those reserves whenever they deem appropriate, thereby capping inflation?
First, it is not just the size of the reserves that are in question; it’s the composition of the assets behind it. Well over half of the Federal Reserve’s balance sheet is TOXIC – long-dated, and still deteriorating mortgage and consumer claims likely marked at prices well above market clearing rates. Gone are the days when the Federal Reserve’s balance sheet was Treasury IOU’s.
Now, in order to withdraw reserves, the Federal Reserve must sell securities. But, if the Federal Reserve is increasingly being “asked” to fund mounting government spending programs by buying Treasury IOUs, that means the only assets it has for sale is overpriced toxic securities. Under those circumstances, do you think the Federal Reserve might have a hard time reducing its balance sheet and withdrawing reserves? Do you think the market knows it too? The last thing the Federal Reserve will want to do is dump these assets onto the market. The mere mention would cause the prices on these assets to tank and interest rates to surge.
Indeed, there is likely only one buyer for these assets at anywhere near current marks, and that’s our spender of last resort, the government. And if the Federal Reserve does in fact decide to sell these assets to the government (for example for optics), how do you think the government is going to pay for it? By issuing IOU’s to the Federal Reserve in return for money printed out of thin air, that’s how. Conjures up a picture of a dog chasing its tail, doesn’t it.
Second, everything the government and the Federal Reserve are doing today is NOT going to turn the economy around. In fact, it’s almost guaranteed to make things worse. A country can not print and spend its way to prosperity, especially one as distorted as ours, particularly when the government, the bastion of inefficiency and waste, is doing all the heavy lifting. The 1930’s are a case in point. As such, this is hardly an environment that lends itself to a contraction in the Federal Reserve’s balance sheet in the eyes of a Ben Bernanke. That’s for sure.
2) What if the banks in the end don’t lend or invest, or don’t to the full extent of the Federal Reserve’s reserve requirements; does that negate the inflation case?
Let’s start with the undeniable fact that even though banks are stock piling reserves, the money supply is still growing at double digit rates. As Doug Noland chronicled, the government, its agencies and the Federal Reserve have all stepped up and are injecting money directly into the economy. The banks have been bystanders, yet, we inflation at double digit rates.
This then raises an interesting question. With all the new inflation tools at its disposal, maybe the Federal Reserve doesn’t need the banks to inflate, at least to the same extent it has in the past. Think for a minute. Are not Fannie Mae and Freddie Mac lending money to home buyers and is this not being financed by the Federal Reserve, both directly through purchases of their debt and indirectly through monies supplied by the US Treasury? Is not the FDIC bailing out bank depositors, ultimately back-stopped by the Federal Reserve’s printing press? Is not the government spending huge and growing sums of money, increasingly being financed by the Federal Reserve? Yes, yes and yes.
Now consider this. What if the banking system is nationalized, a la Fannie and Freddie? Or like AIG. It could happen, if not in name then in substance. Then the banks will be told what do, wont’ they. Now that’s a scary thought, don’t you think?
A whole lot of inflation is in our future, one way or another.
3) How Big this Inflation Cometh?
Ok, lots of inflation and lots more to come. But how big is this inflation, really?
In his April 3rd Interest Rate Observer , James Grant reported that the combined Federal Reserve and US government response to this economic crisis, defined as the change in the Federal Reserve’s balance sheet plus the US government’s fiscal deficit as a percent of GDP, is some 30% of GDP. To put that number into perspective, that’s 10 times the postwar recession average of 2.9% and 3.5 times the previous record of 8.3% seen in you guessed it, the Great Depression.
The size of today’s government’s reflation efforts truly dwarfs anything we have seen in the past and suggests some truly eye-popping price inflation rates in the future. On that score, it’s interesting to note that the greatest price surge in the post gold standard / FDIC era, one that saw the CPI rocket to 15%, began during the 1973-74 recession with a combined Federal Reserve and government response of a mere 4% of GDP. At today’s 30%, and we are not done yet, one can only imagine the kind of price inflation that awaits us this time around.
Please click HERE to read this entire article... MUST READ in-depth analysis!
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