Friday, August 31, 2012

Would The Fed Printing $50 Trillion Tomorrow Create Hyperinflation?

One of the best financial writers on the web today, Michael Shedlock who goes by "MISH," published an article this morning titled "Would Printing $50 Trillion Tomorrow Do Anything?"

It stemmed from one of his readers asking if printing that much money would cause hyperinflation. Mish has been one of the few steady deflationists over the past few years. His definition of inflation is an increase in the money supply and credit. Deflation is a decrease in the money supply plus credit. My definition is the same so we can have an apples to apples discussion here.

The problem that the Fed has faced in generating inflation is that we have a massive debt overhand that has built up over the past 40 years. When debts become too large a burden they default and the total debt/credit market decreases in size. This has a re-enforcing downward cycle on bank reserves which impact their ability to lend (grow credit) even further. The credit market in the United States grew from $1 trillion to over $50 trillion in 2008, and since then it has trended sideways and slowly risen due to massive government spending offsetting consumers deleveraging (paying down and defaulting on debt).

To complete the full scope of this discussion it must be looked at through a worldly lens as there are no borders today with capital flow. To understand how $50 trillion created by the Fed would impact the price of gasoline and food in America, you must look at currency and debt creation around the world vs. debt defaults and money contraction. I am going to table that part of the discussion today in order to help make it easier to understand. We'll just focus on the United States and pretend it is a closed economy (although I promise to take this thought process global in near future for those that want more).

Let's look at both pieces of the equation before we get started. The first is liquid cash, in which we have the Fed's M2 money supply to use as a barometer. This number just recently crossed $10 trillion.

Then we have credit. The following chart shows the most recent release from the Fed on total credit, crossing upward into new highs. We'll call this number $54 trillion (what's a few hundred billion in debt among friends right?). Total credit is composed of consumer loans (credit cards, student loans, auto loans, and mortgages), government debt (treasury bonds), corporate debt (corporate bonds), and debt from the banking sector.

The  last one, the banking sector, is where Mish focuses most of his attention during discussions on inflation. This is again correct as the banking sector is the most important of the four. Why? Because money is loaned into existence. I do not have the time here to explain this concept, but for those that would like a primer see What Is A Ponzi Scheme?

In 2007 the banking sector found itself loaded with residential and commercial real estate loans. Prices began to collapse on the assets behind this debt (real estate) making their portfolios underwater due to the significant amount of leverage they utilized on their balance sheets.

To counter this problem the Fed began QE1 which focused on purchasing mortgages and treasuries from banks in exchange for fresh cash. This lowered their leverage and began to alleviate the pain on their balance sheets. Due to the fact that banks were still underwater, they were taking the cash and parking it, not lending it out as they were before 2007 (this process is still taking place today). The following shows excess reserves at the banks as this new cash continues to be hoarded.

Why is this money not inflationary? Imagine that the Fed prints a trillion dollars and brings it to your home. You take the cash and put it in your garage and close the door. This is not inflationary because the money has not entered the economy. No prices are pushed higher with the cash just sitting in your garage, just as prices are not pushed higher with the money just sitting on bank's balance sheets.

So with this foundation in place we can go back to the original question: Would the Fed printing $50 trillion tomorrow create hyperinflation?

To answer this you must first think about what the Fed would purchase with this money. As a quick primer - the Fed creates money electronically by purchasing an item in the economy that is already in existence in exchange for cash. Imagine you have $1,000 in bonds in your portfolio. The Fed would pay you $1,000 in cash and take your bonds. You then have $1,000 in liquid cash to do with what you like (unlike the bonds which required you to sell in order to spend the money). This is how QE works and how the money supply is expanded (see m2 and bank reserve charts above).

So what would the Fed purchase with $50 trillion? So far they have purchased only mortgage bonds and treasury bonds. The entire debt of the United States government has just crossed $16 trillion. This means they have issued a total of $16 trillion in treasury bonds. The Fed already owns $1.65 trillion of this outstanding amount leaving a remaining $14.35 trillion in treasury bonds they could purchase.

There is currently about $13 trillion in total mortgage debt. The Fed already owns $850 billion in mortgages leaving about $12 trillion in available mortgage debt the Fed could purchase.

This means if the Fed purchased every available treasury and every mortgage bond around the world it would use up about $26 trillion of their available $50 trillion available to spend. That leaves $24 trillion to go.

At this point Mish does not think this $26 trillion in fresh cash now sitting available would create hyperinflation. His reasoning is correct in that most of it would be sitting as bank reserves that could only enter the economy as liquid currency through lending. However, we know that if banks felt their balance sheets were whole with most their debts liquidated then they could put this money to work in other areas such as commodities through their trading units instead of holding 100% of it in cash (sitting in the parking garage). Hold that thought, we'll come back to that in a second.

As a quick side note, I understand that this does not account for the shadow banking market. I will cover that as well in another discussion in the near future.

In his 2002 "helicopter drop" speech, where he promised to drop money from helicopters if needed, Bernanke provided multiple strategies for fighting deflation. The first three in the speech we have already experienced:

1. Lowering interest rates to zero
2. Buying treasuries and mortgages through QE programs
3. Providing long term "guidance" on rates (he has promised to keep rates at zero through 2014)

There is a fourth strategy that he discussed that is usually never mentioned. It can be considered the "nuclear" option. If the first three strategies did not work Bernanke said the Fed could begin to purchase assets outside of treasuries and real estate debt. This could be municipal bonds, commercial real estate, student loans, credit card debt, auto loans, stocks, gold, or your neighbor's fishing boat. The Fed could essentially wipe away the entire debt owed in the United States with a simple keystroke.

This debt is not exclusively owned by banks. The Fed would have to provide cash to insurance companies, pension funds, and every day people in the United States. Mish's argument is that the entire country, sitting on this $50 trillion in cash earning 0% which has been promised through 2014, would simply put it in their garage and never touch it.

He feels no one would buy stocks and more importantly they would not buy commodities such as oil, agriculture, copper, silver, or aluminum. If even a tiny fraction of that $50 trillion in fresh cash were to move into commodities it would create an unimaginable price spike which would in turn lead to a super surge in the cost of living.

To say that $50 trillion printed tomorrow would not create a hyperinflationary scenario is a silly statement. The next question, the one that is more important; what is the amount of printed currency (the magic number between $3 and $50 trillion) that would create a runaway inflation type scenario? That is what we will look at in part two of this discussion.


  1. FTSense

    Good points and really liked what you have to say here about Food and Fuel Inflation in particular.

    Thing is the Fed can create all this Fake Money but can't decide where it will go(unless they work with a specific mandate to purchase all Bonds or all stocks,etc)..

    But the bigger issue is what this Liquidity does?

    Can the Fed Ban all this Liquidity from entering the Food and Commodity markets -No it can't.

    So it will most definitely cause terrible inflation in America.In fact QE1 and QE2 has already caused massive Double Digit INflation in Asia as well as 4-5 percent Inflation in the US.

    When your wages are declining or staying flat at best,even 5percent Inflation is brutal.

    Try telling that to Mish who thinks all the Liquidity in the world won't cause Inflation.

  2. The problem with the above analysis is that the Bond market would collapse. Why would the Fed do something that destroys its own asset? The market would realize the Fed's attempt at monetization and long term debt would collapse (interest rates would skyrocket). This not only makes long term borrowing impossible but all you would have is a cash and carry market.

    1. That is exactly the point. At a certain point the amount of printed currency would change from being viewed as bullish for bonds (traders trying to front run the Fed and tap into lower interest rates) to bearish for bonds (fundamentals would set in where investors would realize purchasing bonds in a depreciating currency is a losing battle).

      When interest rates rise we will have reached the end game, as the only way the Fed can unwind their positions is by selling assets on their balance sheet back into the market. They will be trapped.

  3. I believe we are at over capacity and over supply worldwide. There is not enough demand. So there is no reason to borrow, just reasons to deleverage. That is deflationary. We are still in for deflation until housing has hit bottom.

    This is a great article and I can guess what would happen if the Fed monitized the credit card debts or another of the major bank holdings - they would still sit on the cash as no business needs to borrow and expand (leverage) because they just don't need it until worldwide growth, a lot of worldwide growth, starts to buy more cars, clothes, widgets...

  4. Both hyperinflation and depressionary deflation are forms of extreme disequilibrium in the markets and economies. As Anon says above, the long bond market would at some point collapse under such intense monetization by the FED. I've seen reasonable arguments made that in the 'end game', the powers that be (TPTB) may be allow deflation for quite some time, in order to consolidate their wealth to an even more incredible degree (it's never enough it seems), and then follow that by hyperinflation (in order to be able to pay off all the debt eventually), followed by a reset, where TPTB will weather through to the reset due to all the real assets and gold they own/control. All the average Joe can do is try to control as much real assets as we can to weather both types of storms...and I'd say become debt free...

    Be wise - hedge accordingly.

    1. SeattleBruce I like your comment. My thoughts are the same.

  5. Okay, so when is it time for me to mortgage up on a nice multi-rental (upscale...those foreclosees have to go somewhere) unit and let inflation destroy my loan amount (pay it off with inflated $$)? Only way to play inflation I can see...question is when...

  6. I wrote a reply to Mish's post on hyperinflation:

  7. The Fed wiping out the government debt would also spur more government spending, which is a direct injection of the cash into the economy for consumption. This would spur rapid price rises, i.e. hyperinflation.

  8. excelent article but where is part two mentioned in the end?

  9. Is this site still current? There are several points that are left dangling awaiting Part 2 of this essay -- any one have any info?

  10. All currencies in the world are fiat. No currency can afford to be backed by gold because that would inflate the prices of their exports to a point where nobody could afford them. So, there's this sense of a race to the bottom with currencies. All governments are in that race. So, no currency will fail IF there's not a competing currency to replace it. Again, all competing currencies are fiat and that's what the world central banks want! That's why they easily control the price of gold and silver. The real problem is, we are now a democracy and not a republic. We now have mob rule and with mob rule comes chaos. The government will eventually confiscate all private wealth by decree. This is coming. The elite 1% fear the educated middle class will rise up when they see what the corporate leaders have bestowed upon them. Example: the enormous sale of drone planes to our government that will populate our skies keeping vigilance over our daily lives. We as tax payers will be paying our keepers to control our every movement. Gun control is child's play compared to what they have in store for everyone of us. Your commodities won't do you any good for those who serve the state will report you as a combatant and you will be severely punished for you selfish deeds. No more needs to be said.

  11. Correction... No "Country" can afford to back their currency with gold or silver because this would drastically raise the price of their exports to the point where their economy would fail.