Will the Fed's Fear of Deflation Lead to Rampant Inflation?

The financial pages these days it is easy to see that deflation is the major worry among the world's central bankers including the U.S. Federal Reserve.  The word "deflation" also turns up in articles and interviews with financial advisers.  The price of gold is down and few financial advisers are providing advice or strategies for dealing with inflation.

While there is no question that much of the world economy, including to some extent the U.S. economy and to a much greater extent the European economies, is suffering to some degree from deflation, there is an inflation time bomb lurking just over the horizon.

While I generally don't pay much attention to the doom and gloom concerns of Glenn Beck, I did find myself in full agreement with him this past Tuesday when, on the Sean Hannity show he made reference to the trillions of dollars worth of reserves the U.S. Federal Reserve and other Central Banks have been pumping into the world's banking system since the start of today's ongoing recession.

These trillions of dollars of reserves are new money created by central banks out of thin air and deposited into the world's banks.  While digitally created deposits, this money is basically no different than the massive amounts of paper money printed by the post World War I government in Germany.  The excessive printing of money by the German government resulted in  hyperinflation which led to the rise of Hitler and his Nazi party.

One other difference between the digital funds the world's central banks have deposited into banks and the paper money printed by the post World War I German Weimar Republic is that the digital funds are not circulating but are sitting on bank balance sheets as excess reserves.  So far banks have been hanging on to these funds and not loaning them out due to fear of another financial crises in which they might need these excess reserves to remain solvent.

While central banks intent at the start of the 2007-08 financial crisis was to shore up bank reserves with the injections, subsequent central bank efforts have been an attempt to increase the amount of money in circulation by providing banks with more money to lend.  However, banks have continued to remain cautious and have kept most of this new money as reserves.

The ongoing recession that has resulted from the financial crisis at the start of President Obama's term has been due to people being a fearful as the banks about a future crisis.  Just as the banks have kept the injected funds in reserve, people have been cautious about spending and have used much of their money to pay down debt and build up savings.  This has slowed the circulation of money which has led to fewer sales of goods and services.  This slow down in economic activity has led to layoffs and a reluctance to expand and hire more workers by employers.

This slowdown in the rate of spending by consumers has led to deflation which has prolonged the 2007-08 recession. Deflation is basically a reduction in the amount of money in the economy due to people hanging on to it rather than spending it.  They standard Keynesian policy response is to try to ignite some  inflation (the opposite of deflation).

According to a report on CNBC at the start of the financial crisis, the total amount of new money the world's central banks injected into banks as reserves exceeded the total amount of money in circulation in the world economy at that time.  Since then more money has been created and injected into bank reserves.

What central banks have been trying to do is get banks to move some of this money into the economies of their nations by loaning it out.  This injection of new money into circulation would result in some inflation which would off set or cancel out the deflation and get the world's economy moving and growing again.

However, the real problem is lack of confidence by consumers and business in the Obama Administration's tax and regulatory policies and fear that these will lead to another economic downturn.  In such a climate most people are being cautious and accumulating cash by cutting spending.

Creating money and putting it into the economy via the banking system is a traditional monetary tool for stimulating an ailing economy.  Central banks can also do the reverse and pull reserves out of the banking system which results in banks having less money to loan which forces economic growth to slow when the central bankers feel inflation is accelerating at to rapid a pace.  However, using monetary policy to stimulate or slow down an economy is not an exact science and considerable economic damage is frequently the result of these efforts.

The problem today is that if peoples confidence returns and banks respond by increasing lending there is the possibility that we will go from today's current deflation to rapidly increasing inflation.  If central banks stay focused on deflation and hesitate to act quickly, rampant inflation could result.  On the other hand, if central banks hit the monetary breaks too soon and too hard, the economy could fall back into a recession. 

Convenience of Online Banking

The term "bankers hours" is seldom heard these days, and with good reason. Gone are the days when banks were open from 9 - 3 Monday through Thursday and 9 - 6 on Fridays. Thanks to online banking, banking services are available 24/7. Today practically every banking transaction except making a cash deposit or accessing your safe deposit box can be done online. But with ATM machines even cash (other than coins) and check deposits can be made 24/7 via an ATM machine.

The name of the game here is service and security. We want to be able to access bank services quickly and easily and make sure that our money is safe. Ironically, despite all the Internet scams we read about where people lose money, studies have shown that people who use online banking regularly have fewer losses than those who do their banking the traditional way. The reason is that people who use online banking generally access their accounts online many times a month and can quickly spot when something is wrong. While those who engage in traditional banking have to wait until they receive their statement at the end of the month to see if anything is amiss.

Like services from traditional brick and mortar banks, the services from online banking operations vary in price and quality. However, with online banking you literally have every bank in the nation competing for your business, so you can shop around to find the bank that offers the types of services you want and the quality of service you want either for free or a low price. For instance, my main bank is a totally online and mail operation. They offer excellent service and most of their services are free (free interest bearing checking accounts, free bill pay, free savings accounts, etc.). I can not only move money between accounts at that bank but can move it between other banks that I do business with. To handle things like checks I receive in the mail and my wife's pay check, which is still hand written by her employer, I maintain an account with a neighborhood credit union. Checks are deposited into the credit union ATM and the funds are then moved, via the Internet, to my main bank. We also have the children's accounts at the credit union and have received some good deals on loans from them as well.

Being online, I can access my accounts from anywhere. I also have my paycheck automatically deposited to my checking account. Even when I am traveling out of state or out of the country on pay day, I still have immediate access to my pay check from wherever I am and, using the bank's bill pay service, I can sit down in my hotel room and pay my bills on the spot rather than waiting until I get home and risk a late fee.

However, I have discovered that "online" means different things to different banks. A couple of months ago my wife and I stopped by a couple of car dealerships on a Saturday morning window shopping for a car for our daughter. We found a nice one but did not want to do the financing through the dealer. I drove home, went online with my main bank, filled out an application and received an approval all within about 30 minutes. I printed the approval which stated that I had the loan contingent upon my actually purchasing the car and confirming to the dealership that a check would be FedExed to them on Monday. I picked up my daughter on her lunch break and she had her car before she returned to work. Then a couple of weeks ago I went online with my credit union on a Sunday evening, filled out an application for a Visa card for my wife and I, and submitted it. On Monday evening there was a message on my phone to call the credit union, which I did on Tuesday and was informed that the card had been approved but that my wife and I would have to come in and sign the application. When we arrived we discovered that "signing" the application meant giving a loan officer all the information I had previously submitted on line. He dutifully typed it into the computer, printed it out and we signed it. An hour and a half later we left with the assurance that the cards would be mailed to us shortly. Obviously, some banks have put more thought into their systems than others.

Money, Banking and the Federal Reserve

The attached video is a lecture from the Mises Institute (http://mises.org) explaining the differences between a monetary system based upon a 100% gold standard banking system and a fractional reserve banking system. The concepts discussed in the video are based upon the writings of the late econmist Murray Rothbard one of the outstanding economists of the Austrian School of Economics during the last half of the 20th century.