You know an economy isn’t healthy when banks are using as much of their money to buy government debt as they are to make loans to businesses. That’s just what’s happening right now. According to the Federal Reserve’s latest weekly measure of bank assets and liabilities, released every Friday, banks held 1.37 trillion of Treasury and Fannie Mae or Freddie Mac debt securities at the end of October and $1.37 trillion of commercial and industrial loans.

We’ve seen this movie before — in the early 1990s after the savings and loan crisis and in the early part of this decade, after the tech bust Treasury holdings exceeded business lending. What’s stark about the latest version is that business lending is falling so fast and Treasury purchases are rising so fast. At the end of October, business loans were down 17% from a year earlier, while Treasury and agency debt holdings were up 8%. Total bank loans and leases are down 8%.

These trends are important for several reasons. First, this helps explain why yields on Treasury bonds are so low even with mammoth U.S. budget deficits. Credit-wary U.S. banks are helping to finance this deficit because they’re afraid to put their money anywhere else. They can still earn a good, low-risk return buy borrowing very cheap short-term money and parking it in higher yielding Treasury bonds. They’re not the sole factor, but they contribute. Second, this should help to allay some of the market’s concerns about inflation. It’s hard to get inflation when unemployment is so high. It is also hard to get it when banks aren’t lending money. This is one factor that is likely to keep the Fed on hold for some time.

The central bank puts out its Senior Loan Officer Survey this afternoon, a quarterly survey on lender attitudes about extending credit. In the July survey, loan officers said decreased loan demand and deteriorating credit quality were driving the contraction in business lending. Most banks also said they expected their lending standards across all loan categories would remain tighter than average until at least the second half of 2010.