Sunday, November 2, 2008

Monetary Inflation Rate Now at 341% per Annum

Gary North (October 24) writes:

I have never seen anything like this. The adjusted monetary base over the last eight weeks has risen at 341% per annum. The increase in the monetary base is $300 billion.

This indicates panic at the Federal Reserve. The financial system is coming unglued.

The monetary base is high-powered money. For every dollar injected here, the money supply can rise by at least 10 to one. A 10% reserve requirement is imposed on large urban banks, i.e., a 10-to-1 multiplication factor. This is the fractional reserve banking process. This is from the Federal Reserve's site.

The recession is pushing down the price of commodities. So far, the new money has gone to banks and financial institutions. They are not lending to businesses. They regard businesses as too risky.

When the banks do start lending again (which North figures will happen at the first sign of economic recovery), this tsunami of fiat dollars will enter the economy, causing severe inflation if not hyperinflation in prices.


SurvivalBlog reader Michael W. disagrees with the inflation forecast, at least in the short term. He draws a distinction between the principles and effects of credit expansion versus those of increasing the paper money supply:

In the US the amount of credit used is orders of magnitude more than the amount of currency in circulation. Credit can be destroyed. If the value of your house goes down by $100,000, that $100,000 is just gone. It doesn’t exist any more. It is not in the money supply. This is deflationary. Further, if the bank repossesses your house and then sells it to someone else, the difference in sale price has an effect on the banks ability to lend. If they lose $100,000 on your house then they have effectively lost the ability to lend $1 Million because of the fractional reserve system. That $1 Million is not in the money supply any longer. That is deflation. And, of course, the amount of money that will vanish in exactly the same way as part of the derivative mess is orders of magnitude larger than the amount to be lost due to housing.

As can be seen by looking at virtually anything in the last few years (gas, oil, corn, gold, wheat, houses, cars, the Dow, etc.), prices for everything have gone up while there was credit in the system and banks wanted to lend. Now there is dwindling credit, severe unwillingness to lend, and a Fed that is contracting the ‘money’ supply. Value/dollars/money is vanishing at an unprecedented rate. Prices on everything are coming down hard. This is deflation. Your dollars are becoming more valuable, not less. Hold on to cash.

I know this is counterintuitive, and I am an abject Austrian regarding economics. But, the majority of people (including many Austrians) are fooled by the difference between an expansion of cash and an expansion of credit. Weimar Germany, Argentina, Mexico, Zimbabwe – these places all created lots of currency and had rampant inflation. We cannot use that as a model. In the Great Depression we had deflation because the Fed contracted the money supply. This is well documented, as are the effects. This is the model we need to use now. The effects this time around will be much worse, they have the same genesis and the same result. People will need/want/hoard cash.

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