Where is Inflation?
Note: This commentary was originally posted to Metal Augmentor on June 15, 2009 at 10:27PM EDT.
Last October, I wrote a commentary called Monetary Base Rocket. In it, I argued that the liquidity and bailout programs of the Federal Reserve under the leadership of “Helicopter” Ben Bernanke were the equivalent of a monetary drop from a proverbial helicopter, but with an important caveat:
The Fed has added as much to the monetary base in 6 weeks as it has added in any prior 10 year period going back to the early 1980s. Indeed, the rate of increase appears to be about $100 billion every two weeks and yet the logjam in the credit markets still has not been cleared.
So, is this the fabled helicopter drop? Yessirreee! There is, however, a slight matter that deserves some mention. The money dropped from the helicopter has not reached the ground yet. In other words, most of this money is still being held by the banks in the form of Reserve Balances. Put another way, it has not yet started to work its way down through the fractional-reserve lending process to the credit-strapped private sector.
The reason these funds are being held and not loaned out by the banks is simple. The Fed is actually paying banks to hold the funds in reserves. Indeed, the Fed has just today increasing the rate it is paying by 40 basis points. Some of you may know that the Fed was originally going to start paying banks for excess Reserve Balances starting in 2011 but the recent emergency bailout legislation moved that date up so that Reserve Balances would start to earn interest immediately. The Fed’s intent is to try to keep the massive increases in Reserve Balances close to the heart so that these funds serve mainly to shore up the banks’ balance sheets but don’t create a tsunami of “unnecessary liquidity” in the money supply. Remember what I said earlier about jumping out of a burning building. In helicopter lingo, the $300 billion has been dropped but it is fluttering in midair due to an updraft created by the rotor.
I suspect, however, that the Fed will have to dispense with its “gradualism” before too long and fly the helicopter to open airspace in order to avoid a crash. Even if the Fed has no intention of moving clear, the longer the money stays out there fluttering in midair, the more difficult it will be to keep it aloft. Moreover, once the dropped money has cleared the updraft from the helicopter’s rotor, it can no longer be reclaimed by the Fed without consequences, especially while the global economy remains on an unsure footing. Thus I suspect most of the dropped money will eventually flutter to the ground.
What I think we should watch for in particular is an increase in M1, which includes circulating currency (Federal Reserve Notes) and demand deposits. The latest data only goes up to October 13, but that data actually shows weekly average M1 shrinking by as much as $100 billion since the end of September. If and when we see M1 reverse sharply upwards, we could start to suspect that the first batches of the monetary drop are starting to reach the ground and that a “hyperinflationary event” will not be very far behind. How long could this take? I give it 6 to 18 months although others say it could be literally weeks from now. Jim Sinclair claims something big will happen in 13 to 88 days, which is the timeframe between the U.S. elections and the inauguration of the next President.
The caveat was that the helicopter actually has to fly clear of the money fluttering in the sky so that it can start falling to the ground. Much has taken place since I wrote the above piece and several related ones but the simple fact is that the helicopter has not flown clear. The money drop continues to be kept aloft primarily because banks are unwilling to lend their borrowed Reserve Balances as there are no qualified borrowers who need loans. Also, there is a stigma attached to these borrowed Reserve Balances. Lending them out means they won’t be paid back anytime soon, which is a reason of itself not to lend them out. Indeed, some of the money drop has even been sucked back up. For example, the largest bailout program, named Term Auction Credit, has seen outstanding balances drop from $493 billion in early March to $337 billion last week. On a related front, a number of banks have announced they will be paying back their TARP money as well.
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