Inquiring minds are wondering about the possibility of "pent-up" inflation from the massive expansion money supply by the Fed. Our search for the truth starts with the question "Which Comes First: The Printing or The Lending?"



This is a critical question given the massive expansion of base money by the Fed as shown in the following chart.



Base Money Supply







Since the beginning of the recession, the Fed has expanded base money supply from $800 billion to $1.7 trillion. Conventional wisdom suggests this money is going to come soaring into the economy at any second causing hyperinflation on the notion banks will lend out 10 times the amount of reserves.



So is this pent-up inflation just waiting to break out?



Hardly.



A funny thing happened to the inflation theory: Banks aren't lending and proof can be found in excess reserves at member banks.



Excess Reserves







Banks are Insolvent, Consumers Tapped Out



Because of rising credit card defaults, commercial real estate defaults, foreclosures, walk-aways, and other bad debts, banks need those reserves to cover future losses.



In practice, banks are insolvent, unable or unwilling to lend. Moreover, tapped out consumers are unable or unwilling to borrow. As a result, Spending Collapses In All Generation Groups.



Bernanke can flood the world with "reserves" and indeed he has. However, he cannot force banks to lend or consumers to borrow.



Yet every day someone comes up with another convoluted theory about how inflationary this all is. It is certainly "distortionary" in that it creates problems down the road and prolongs a real recovery by keeping zombie banks alive (as happened in Japan). However, it is not (in aggregate) going to cause massive inflation because it is not spurring the creation of new debt.



Consumers and banks both are suffering from a massive hangover. Their willingness and ability to drink is gone. No matter how many pints of whiskey Bernanke sets in front of someone passed out on the floor, liquor sales will not rise.



In a debt-based economy, it is extremely difficult to produce inflation if consumers will not participate. And as noted above, demographics and attitudes strongly suggest consumers have had enough of debt and spending sprees.



Those pointing to flawed measures of money supply as proof of inflation just don't get it, and likely never will.

Banks Lend, Reserves Come Later

Steve Keen On the Edge

Did The Government Rescue The System?

In explaining his recovery program in April, President Obama noted that:



“ there are a lot of Americans who understandably think that government money would be better spent going directly to families and businesses instead of banks – ‘where’s our bailout?,’ they ask ”.



He justified giving the money to the lenders, rather than to the debtors, on the basis of “the multiplier effect” from bank lending:



"The truth is that a dollar of capital in a bank can actually result in eight or ten dollars of loans to families and businesses, a multiplier effect that can ultimately lead to a faster pace of economic growth. "



This argument comes straight out of the neoclassical economics textbook. Fortunately, due to the clear manner in which Obama enunciates it, the flaw in this textbook argument is vividly apparent in his speech.



This “multiplier effect” will only work if American families and businesses are willing to take on yet more debt: “a dollar of capital in a bank can actually result in eight or ten dollars of loans”.



So the only way the roughly US$1 trillion of money that the Federal Reserve has injected into the banks will result in additional spending is if American families and businesses take out another US $8-10 trillion in loans. What are the odds that this will happen, when they already owe more than they have ever owed in the history of America?



If the money multiplier was going to “ride to the rescue”, private debt would need to rise from its current level of US $41.5 trillion to about US $50 trillion, and this ratio would rise to about 375% — more than twice the level that ushered in the Great Depression.



Obama has been sold a pup by neoclassical economics: not only did neoclassical theory help cause the crisis, by championing the growth of private debt and the asset bubbles it financed; it also is undermining efforts to reduce the severity of the crisis.



This is unfortunately the good news: the bad news is that this model only considers an economy undergoing a “credit crunch”, and not also one suffering from a serious debt overhang that only a direct reduction in debt can tackle. That is our actual problem, and while a stimulus will work for a while, the drag from debt-deleveraging is still present. The economy will therefore lapse back into recession soon after the stimulus is removed.