ANTIESTABLISHMENTARIAN

Hyper Inflation Is Unlikely:

Something Even Worse Is

To fully understand why a highly inflationary outcome is unlikely, we need to look at the money creation side of banking and its relationship to the economy as a whole. Lets first start with the fact that the US economy is badly unbalanced. It had the bizarre notion that it could dispense with manufacturing and become a financial and service economy, and therefore got rid of 54% of its manufacturing. As we will see, this plays an important role in the inflationary scheme.

The definition of inflation is an excessive increase in money supply, the EFFECT of which is rising prices. However, for years this excess money creation was kept largely in check by the exporting of those excess dollars via the trade deficit. Those dollars accumulated in China and other export nations such as OPEC. We thus sent money abroad in exchange for cheaper goods, thereby holding prices down.

Under the fractional reserve banking system, all money is borrowed into existence. The dollar is itself a debt note of the Federal Reserve. In theory, the Fed can control how much banks lend; in reality it sometimes cannot. As we have seen, the Fed can’t force banks to make loans. So if the money can’t be borrowed into existence by the consumer, it isn’t possible to drive inflation.

The banks got in trouble and went broke as a result of making loans to too many people would couldn’t repay those loans. As a result their capital base shrunk and they were unable to continue lending. The government proposes to recapitalize the dead banks so they can begin lending again. At this point we seen an obvious problem. In the last ten years credit expanded at an unprecedented pace with collective private debt increasing some 350% since 1980. The public is up to its ears in debt. With a slight downtic in the economy, defaults began increasing, leading to a downward spiral of declining economic activity and increasing defaults until it reached the point that the banking system collapsed. Yes, there were many other factors involved like subprime, derivatives, etcetera, but I’m trying to keep it simple here to avoid confusing the issue.

Bloomberg (10-13-08) Treasury Secretary Henry Paulson urged banks getting $250 billion of taxpayer funds to channel the money to customers quickly to halt a credit freeze that’s threatening to bankrupt companies and hammer the job market.

While the government is literally showering the banking system with money, and since new money has to be borrowed into existence, we need to inquire who is going to do all this borrowing in order to cause inflation? The same consumers who are already overloaded with debt? So we see that in order to attempt to reflate the economy, it will be necessary for banks to continue making more bad loans!

What about businesses, won’t more borrowing by businesses create more productivity and spur the economy. Well, we are faced with the proverbial chicken and egg question. The economy is winding down fast and unemployment rising, leading to ever more defaults. The consumer is hard pressed by stagnant wages, excessive debt and existing high inflation so he’s slashing his spending. Into this scene we want to increase production (or imports) to a public that isn’t buying? So, you see, this $2 trillion money flood is being showered on the very top of the economic pyramid with no way for it reach the hands of Mr. Consumer who, without his spending cannot drive up prices. Add to this the high energy cost that is further sapping his spending power.

Forty years ago during the great inflation of the 1970’s the term wage-price spiral was a household term. Back then we had a lot of manufacturing and many labor unions. Once inflation got a toe-hold, it was labor unions that forced though the big wage increases that put more money in consumers hands to drive up prices. This is in contrast to today when there is little manufacturing and even fewer labor unions. Instead, we export most of our inflation (excess dollars) by means of sending our money overseas to purchase imports, thereby causing inflation in other nations.

What we have been witnessing for ten years or more is the wage-price spiral working in reverse. By exporting inflation, we drove up the cost of imports at the same time as the pressure on wages and salaries is downward. Thus we ended up with rising import prices and less income with which to buy them. Why? Because service sector jobs are not as productive as manufacturing jobs and so average wages declined. Since 2002, much of this income gap was made up for through the home ATM machine, but now with home equity all but wiped out, there is no chance of reviving that credit engine.

Moreover, we are now in a situation wherein people, not trusting banks, are increasingly pulling money out of banks – even if only in relatively small amounts — and sticking it under the mattress, further decreasing the money supply, and while you might call this savings, its not savings available for lending.

While its true that in the last two weeks we’ve seen a big jump in the monetary base, thereby increasing bank reserves and ability to lend, we have to ask the question: to whom will they lend in such a way as to cause hyperinflation. Some will immediately claim that government spending will do the trick. Well, both Hoover and Roosevelt tried that for years and it didn’t work; it never works. Ask the Japanese, the last country to try that Keynesian trick.

In all probability the bulk of bank lending will once again go the Wall Street gunslingers, creating yet more bubbles in asset prices, including the bizarre phenomenon of rising equity prices with falling earnings. This will likely be paralleled by a collapse in Treasuries followed by a dollar collapse as the rest of the world goes down in inflationary flames caused by a multi trillion flood of dollars.

In any event, hyperinflation would be an outcome to be prayed for in the face of $530 trillion worth of dollar denominated credit default swaps written around the world. This is the reason why central banks throughout Europe and elsewhere have gone to unprecedented lengths to bail out banks that haven’t even failed yet. The truth is known as cascading triggering CDS, the silent weapon of mass financial destruction. Its like one fellow put it, this is like throwing a handful of golf balls into a room filled with a thousand rat traps. Or perhaps like a string of Chinese firecrackers.

Richard Bellingham of Resourceful Bear blog sums up the following pertinent points;

While the Fed has done awesome things to provide financial system liquidity, including in effect lowering the Central Banks interest rate to zero through offering unlimited dollar funds, the Federal Reserve will be unable to stimulate lending in the marketplaces and the credit gridlock, that is, the lending gridlock will continue for a number of reasons:

1) The banks know they are walking dead men, and simply want the TARP swaps to help preserve their balance sheet.
2) They are aware the consumer is tapped out and overextended and at risk for non payment of loans.
3) They want to preserve capital as they and their customers have exposure to settlement of credit default swap derivatives on Lehman Brothers and others.
4) There is no trust between lender and debtor as the fair value accounting rule of the SEC, and the mark to market provisions of FASB 157 have been thrown out the window.
5) There is an awareness that the CPFF facilities are for the top tier Fed invested nine banks.

The stock markets will crash again with a matter of days. It will be only one more crash of many more to come.

The auto industry is collapsing, Ford and GM are walking deadmen. Airlines are now mothballing aircraft by the thousands, not hundreds as previously. This spells death for both Boeing and Airbus. Most existing orders will be canceled, leaving those companies broke.

Regardless of whatever else happens in the interim, the bankruptcy of Boeing will have enormous psychological effect, and will signal the descent into depression. The 70% consumerist economy – which was always a matter of lunacy made mad – goes in the tank and no one has any money to spend because too many jobs will be lost. It them becomes impossible to have inflation, yet alone hyperinflation.

The $2 trillion being flooded into the economy has gone into the black hole of fictitious capital and derivative implosions. It is having virtually ZERO effect on the credit seizure. Banks will not lend because they know all this and trust no one. America’s great credit party is finally and truly over.