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If The Money Supply Is Exploding Why Are We Not Seeing Rampant Inflation?

The U.S. money supply has been expanding at an absolutely unprecedented rate.  So why are we not experiencing rampant inflation?  Why is the U.S. dollar not falling through the floor?  Well, the truth is that all of this new money has gotten into the U.S. financial system but it is not getting into the hands of U.S. businesses and consumers.  In fact, even though the money supply is exploding, U.S. banks have dramatically decreased lending.  This has brought us to a very bizarre financial situation as a nation.

What we have seen is the U.S. government shovel massive amounts of cash into the U.S. financial system and then watch as the big banks sit on that cash and refuse to lend it. The biggest banks in the U.S. reduced their collective small business lending balance by another 1 billion dollars in November 2009.  That drop was the seventh monthly decline in a row.  In fact, in 2009 as a whole U.S. banks posted their sharpest decline in lending since 1942.

So all of this money that the U.S. government pumped into the financial system has been doing American businesses and consumers very little good.  That is why we can have a vastly increased money supply (as you can see from the chart below) and very little inflation.

So if the banks are not lending the money to the American people, what are they doing with it?  One of the things they are doing with it is buying U.S. government debt.  As you can see from the chart below, U.S. banks have cut business lending by approximately 350 billion dollars since early 2009 and they have purchased approximately 300 billion dollars worth of U.S. Treasury securities.

So instead of loaning money to American businesses and consumers who desperately need it, a ton of this new money is being used to pump up yet another bubble.  This time the bubble is in U.S. Treasuries.  Asia Times recently described how this trillion-dollar carry trade in U.S. government securities works....

Remarkably, the most aggressive buyers of US government debt during the past several months have been global banks domiciled in London and the Cayman Islands. They borrow at 20 basis points (a fifth of a percentage point) and buy Treasury securities paying 1% to 3%, depending on maturity.

This is the famous "carry trade", by which banks or hedge funds borrow short-term at a very low rate and lend medium- or long-term at a higher rate. This works as long as short-tem rates remain extremely low. The moment that borrowing costs begin to rise, the trillion-dollar carry trade in US government securities will collapse.

So what happens when this bubble collapses?

Nobody knows for sure.  But anyone who has dealt with carry trades in the past knows that when carry trades unwind they can do so very, very quickly and the results can be nightmarish.

The truth is that the U.S. financial system is a house of cards that could fall at any time.  A lot of economic pain is on the horizon - it is only a matter of when it comes and how bad it is going to get.  Trends forecaster Gerald Celente is predicting that it could be as soon as this year....

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  • http://MyThirdRail.com MyThirdRail

    “So instead of loaning money to American businesses and consumers who desperately need it,”

    That is a very large and incorrect assumption. IF either of those groups required the debt financing they could easily get it. Business are scared of the uncertainty, volatility, in their businesses.

    The consumer is not spending in an attempt to unwind debt and float what debt they do have with what income is left post lay offs.

    Think of the velocity of money as a sprinkler in your yard that someone has a firm grip on. That firm grip is the consumer/business that knows that the grass isn’t growing…… so why bother watering it with capital?

  • Cvan

    A lot of us are wondering the same thing. I think the tactic could be:

    1. Give the banks a ton of money at near zero interest rate

    2. Have them invest in stuff which earns a few percent plus.

    3. Do this until the gains make up for some/most of the losses.

    4. Somehow return or destroy the borrowed money and have it disappear.

    It’s probably too simplistic, but if the money isn’t going to individuals/businesses, no one’s the wiser and when the banks earn back their losses- the money isn’t going to be seen again, destroyed by some dragged out convoluted series of overnight transfers.

    Therefore people wouldn’t have more cash to spend, avoiding inflation, banks would earn back their losses passively in interest, and those who kept track of the numbers and made announcements would be ignored.

  • http://www.my-wedding-chair-covers.com Kelly

    I had no idea banks could borrow from the fed at a low rate and then get a better return on U.S. Treasuries.

  • http://thelibertyguardian.com MJ

    Great Post. We’re all just waiting for the treasury bubble to burst. It could be a while before we feel the real effects of inflation.

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  • Mr Pike

    Great. Now it looks like the quote “Permit me to issue and control the money of a nation and I care not who makes it’s laws” needs to be changed to “Permit me to to completely control the people of a country by issuing money only to myself”. Why not if you can tell nobody’s going to do anything about it? This causes riots in other countries, is there something in our food and water or is it T.V. or what??? The recent passage of Obamacare demonstrates that it doesn’t matter who makes the laws because laws are purchased with money. Nothing new just a little more out in the open this time and it took a lot more money than usual. I think every one will see at a future date that this law was the will of the bankers as opposed to “social justice” – just take a look at the President’s Cabinet and his actions up till now. What more can be achieved now that the quote has changed and people begin to starve? The original quote needs to be reversed engineered to come up with the obvious solution to break this control over Americans. Reverse engineering always leads to only one result. Something so simple and obvious that not many see it even when it’s being held right under their noses. Kind of like trying to find the Big W if you remember the movie “It’s a Mad Mad Mad Mad World”. The American People have got to stop using Federal Reserve Notes and return to gold and silver. Many other countries agree so it will have not negative effects on trade or anything else other than the creation of bubbles. Bubbles destroy. When this bubble bursts their control of our money will be even more painful than now because the FNR’s that we now have will be greatly devalued along with the newly released ones. Also the size of the Federal Government needs to be immediately cut in half for starters. If Federal Reserve Notes are continued to be used by Americans, even a 100% complied with tax revolt will be futile, they’ll just print up what they need and we will be paying taxes 100% via inflation as opposed to what ever the real inflation rate is now. “You tried to cut yourself in twice, now you’re out”. Simple.

  • P Riehl

    Thanks for this explanation!

  • lk

    can’t blame banks for not lending, billions in real estate losses still on their books, both residential and commercial. credit card losses through the roof. small businesses loans losses that staggers the imigination, and i can keep going.

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  • http://www.TheAngryGrapes.com Mark

    There are strong deflationary forces at play. The super easy credit since 1998 resulted in people and businesses borrowing more than they can service. From the demand side, the private sector is now in the process of fixing their balance sheets. This means eliminating debt by either paying it off debt or defaulting on it. From the supply side, “Normal” lending standards of lending to those you can repay debt means the pool of qualified borrowers smaller.

    What is occurring right now is that private sector borrowing is being replaced with public sector borrowing. So total borrowing is stagnating. We are now seeing the financial stress of public sector borrowing is places like Greece. So the next step will be reductions in public sector borrowing brought on by higher interest rates. If this occurs, we might see a significant drop in prices.

    We are living in interesting times!
    http://www.TheAngryGrapes.com

  • Ken F

    Interestingly, the Constitution directs the Treasury only to mint silver coins. Our money was always to be on a silver standard, not a gold standard, and never a silver AND gold standard to avoid the unavoidable fluctuations in price between the two. You can’t have two “standards.” Gold would be priced in relation to the current price of silver. The government should put us back on the “silver standard” because that is Constitutional. That will never happen of course. But like Mr. Pike says, we can put ourselves on a hard currency standard to protect ourselves from the coming devaluation. And I agree, but how will we buy groceries with a few ounces of silver or gold?

  • Ken F

    Oh, and don’t forget…the last time the economy teetered so badly, FDR confiscated the gold. This “Guy” will do worse than that.

  • Mr Pike

    IK: If you had kept on going would you have gotten around to mentioning derivatives as in some peoples estimate of 1.5 quadrillion in potential losses to these banks as a reason the banks are hesitant to loan money? With out this black hole of fraudulent financial inventions the banks would still be lending at least for now and maybe our economic disaster would still be reversible. They put all of the blame on the American People for the crisis for one entire year after it began and the term Credit Default Swap was not heard on their media outlets until they had to mention it because too many of us had learned what they were on the internet. They wanted to put all the blame on us for buying houses we could not afford and entering into bad loans – a drop in the ocean compared to the fraudulent gambling spree they went on knowing they had the power to force the taxpayers to bail them out, and who knows what the actual amount of bailout was with all the crooks in DC working for them. To come up with an estimate start with their actual losses which for sure is over 50 trillion. The world’s GNP is 60 trillion, how much debt did the American People get into that they will not pay compared to that? Most are paying or will pay what they owe sooner or later, they are not bankers. It is not a housing crisis it is a derivatives crisis based on collateralizing mortgages that would have been payable mortgages for most if the derivatives crisis had not been perpetrated intentionally destroying jobs and economic activity through a freeze of bank lending. Pike.

  • Mr Pike

    Ken F, I stand corrected you are correct we left the silver standard in 1971 although gold coins were used a lot earlier. I don’t know how we get the silver into the hands of the population or get the grocer to accept it. I’ve never thought about that but there must be a way. I know some communities have local money and at least one was based on silver I believe. To do it on a nationwide scale it seems to me would have to be done in our legislature which could work very well if laws were enforced. But it would have to be done by a new political party or with the same ones but with new representatives that obey the U.S. Constitution. This would entail taking the power away from the people who control the Central Bank. Notice that I didn’t say our Central Bank? Dirty robbers are ruining our lives and country and we are not doing anything about it so far.

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  • RobertM

    One of the things they are doing with it is buying U.S. government debt. As you can see from the chart below, U.S. banks have cut business lending by approximately 350 billion dollars since early 2009 and they have purchased approximately 300 billion dollars worth of U.S. Treasury securities.

    You forgot to mention that the US banks borrowed that money from the Fed (i.e. taxpayers) at 0%. Outright theft if you ask me.

  • http://321gold kenny

    Bottom line who the heck knows whats gonna happen in the gold and silver arena this time around…….but some plan is better than no plan……but don’t leave God out.

  • Sid Davis

    First of all, the Adjusted Monetary Base is not really the money supply. It is not included in the definition of M1, M2, or M3.

    The Monetary Base makes up bank reserves. Banks hold federal reserve notes in their vaults so that when people want to cash a check the bank has available cash to give them. Banks hold checking accounts with the federal reserve banks in order to cover check clearing. The higher a bank’s reserves, the greater their ability to create money (M1, M2, or M3) out of thin air and loan it to individuals, businesses, and governments.

    When the crisis hit, banks did not have adequate reserves to meet demands and continue to expand the money supply by making new loans. This was a liquidity crisis, and it was easily solved by the federal reserve bank creating checking accounts on their own books and loaning these checking accounts to banks, but these checking accounts that banks hold at the federal reserve bank are interbank accounts and not part of the money supply, and these balances are not driving inflation because they are not getting into the hands of businesses and individuals, although the profligate federal government is borrowing what it can to prevent its own bankruptcy.

    Here is an indication of what is really happening to the money supply (M3 is collapsing):

    http://www.nowandfutures.com/key_stats.html

    If you go to the St. Louis federal reserve website and look at the year over year growth rate of M2 and M1 they are certainly not hyper-inflating. The fact that M3 is deflating, M2 is very anemic, and M1 is growing at no more than historic norms, tells us that savings are being eroded, and that what money is being held is in the most liquid form (federal reserve notes and your checking accounts), a sign of fear and desperation as people consume their savings to survive.

    There seem to be several myths about money. One is that the US government issues (prints) money into circulation; this is false; banks create new money (federal reserve notes and checking accounts)and loan them into existence. The Treasury may print up federal reserve notes, but they do not issue them; the federal reserve bank does; you carry around federal reserve notes (bills of credit), not treasury notes. So if the money supply is to be inflated, the banks must make loans to businesses, individuals and governments at a faster rate than prior loans are being repaid; they must find credit worthy borrowers to borrow the out of thin air money. The banks must trust the value of the collateral for these loans and this is a catch 22, because in order to drive the value of collateral (like real estate) the banks must accept that the value will not collapse, but failure to make the loans causes the value to collapse.

    Only if the monetary system is changed is hyper-inflation possible. If the US treasury begins to bypass the banking system and issue its own bills of credit (greenbacks or treasury notes) by spending them into existence then hyper-inflation is possible.

    It is much more likely that money will become worthless, not from over issue, but from bank insolvency which makes your checking and savings accounts worthless, and ultimately makes people unwilling to accept federal reserve notes as the federal reserve bank fails also. Your checking and savings accounts are liabilities of your local banks; federal reserve notes are liabilities of the federal reserve bank. And this will likely be coupled with collapse of the federal government, just as the USSR collapsed.

  • Maurice

    Thanks Sid, you are the first that manages to explain money supply in a simple and understandable way!

  • http://www.watchman2009.blogspot.com cliff hilbert

    The Eye of the Storm
    August 14, 2009

    Right now we are in the rather calm eye of the storm. But the worst damage comes after the eye passes and the winds come from the other direction. The first winds of this storm weakened the economic structure in this country, but they didn’t destroy it. At this date, there is a relative calm in the economy of this country – it seems to have stabilized and the stock market has rallied. Our politicians and newspapers are declaring that the recession is over and there will be good times ahead. DON’T BELIEVE THEM!!!!

    This is just the calm in the eye of the storm. The winds are about to hit us from another direction and they will completely destroy the economy of this country. It is coming very, very quickly. Be prepared to live on virtually nothing. Be prepared to live without many of the conveniences you have today. Be prepared for exhorbitant price increases on everything from food, to electricity, to gasoline, to clothes, to just about anything you buy. Hyperinflation is coming very, very quickly.

    You must learn to do with much less than you have today. Energy prices will skyrocket to unbelieveable levels and many of you will not be able to afford to air-condition or heat your homes. Gasoline prices will be higher than anyone could ever have predicted, be prepared to drive only for essential errands. Food prices will skyrocket and you will be able to afford only the basic necessities. Salaries WILL NOT rise accordingly. Cut back on your expenses and save as much money as you can.

    I can’t tell you how dire this warning is! It is from the Lord. When I woke up this morning I had no idea that I would be writing this today. But I read something in this morning’s Dallas Morning News Business section where the reporter asked the question “Are we in the eye of the storm?” Then the Lord put this message upon my heart.

    What should you do? I don’t give blanket advice except to tell you to spend more time in prayer and fasting, asking the Lord what He wants you specifically to do. His direction will be different for different people. I do believe that many families and friends will be living together to try to conserve money and resources. I do believe that it is time to begin planting your own vegetable gardens. I do believe that it is time you learned to ride bikes again. I KNOW that it is time to get your prayer life in order and make it the most important part of every day. Turn off that idiot box and pray and read the Bible. Seek the Lord while He may be found. The days of darkness are almost upon us.

    http://www.watchman2009.blogspot.com

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