Inflation, Bank Lending, and the Employment Spiral
Posted Apr 5, 2011
Here are excerpts from recent commentaries posted at www.speculative-investor.com.
Can inflation happen when the banks aren’t lending?
We can state with absolute certainty that "yes" is the correct answer to the above question. We know for a fact that the total supply of money can increase in parallel with a contraction in the commercial banking industry's collective loan portfolio because that's exactly what has happened in the US since October of 2008. As illustrated by the following chart, "total loans and leases at commercial banks" (the blue line) peaked and began to trend downward in October of 2008. As also illustrated by the following chart, True Money Supply (the red line) has trended upward in parallel with the post-October-2008 decline in bank lending. In fact, the rate of growth of the money supply accelerated after bank lending went into decline!
Considering what has happened over the past few years, why do some analysts continue to claim that commercial banks must be willing and able to expand their loan books, and that the public must be willing and able to take on more debt, in order to get growth in the economy-wide supply of money? We don't know; you'd have to ask them. Clearly, they are wrong.
The US money supply, when properly measured, has grown rapidly in the face of reduced bank lending over the past 2.5 years because the Fed and the private banks have combined to monetise a huge dollar-amount of securities. There is possibly a limit to how much the private banks can monetise, but the Fed's ability to monetise has no rigid bounds. It really just comes down to how much risk the Fed is prepared to take in its efforts to "stimulate" the economy, and how much monetary inflation the bond market is prepared to tolerate.
When the US eventually reaches the point where "inflation" is widely believed to be the most important economic problem facing the nation, actions that put a stop to the Fed's monetary profligacy could become politically feasible. We currently appear to be a long way from that point.
Another nail in the coffin of the deflation argument
The following text and chart are from John Hussman's latest weekly commentary:
"...the poor performance of the U.S. economy from an employment standpoint cannot be separated from the Fed's attempts, for more than a decade, to make easy monetary policy a substitute for the accumulation of real savings and investment. ...Speculating and consuming off of cheap credit may feel better than saving, but the long-term results are profoundly different."
It could be argued that factors other than the policies of the Fed and the US federal government have contributed to the multi-decade downward spiral in US employment growth illustrated above, but discussing these other factors only clouds the issue. The reason is that the reduction over time in the US economy's ability to create productive jobs is consistent with what Austrian economics (good economic theory, that is) predicts would be the result of the market distortions introduced by the Fed and the government. Looking beyond Fed-sponsored inflation and the government's meddling in the economy to explain the economic deterioration would be akin to someone sitting in a sauna, with the temperature control cranked up to the max, looking for reasons unrelated to the sauna for why he/she is uncomfortably warm.
Unfortunately, very few people are looking in the right direction in their efforts to diagnose the cause of the decline and come up with solutions. As discussed last week, that's why we are long-term bears on the US economy. There will be no hope as long as the causes of the problem are misdiagnosed, because the proposed solutions will almost certainly be wrong if the true causes of the problem are unknown. In fact, if past is prologue then the proposed solutions will be exactly the opposite of what is required and will make things worse. For example, bad economists will recommend, and ignorant and/or unprincipled policy-makers will bring about, more inflation of the money and credit supplies in an effort to combat the problems caused by earlier inflation of the money and credit supplies.
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