Many economists and market commentators fear that the US and other countries with large budget deficits (in their own floating rate currency) face hyperinflation if they; “continue to print their way out of the current problem”. Many also fear that in the example of the USA “Helicopter Ben” has pumped so much “money” into the system and the economy that extremely high inflation, if not the phenomena of hyperinflation, will be the inevitable result.
The Weimar republic reference is the usual, arguably intellectually lazy, stereo typical vision that’s suggested; the natives of a country suffering Zimbabwe levels of interest and using the paper money to stoke fires, were fruit is a more stable currency than paper. But does this theory really hold water?
Ben Bernanke is an American economist, and the current Chairman of the Federal Reserve, the central bank of the United States. During his tenure as Chairman, Bernanke has overseen the response of the Federal Reserve to late-2000s financial crisis.
He served as Chairman of President George W. Bush’s Council of Economic Advisers before President Bush appointed him to be Chairman of the United States Federal Reserve on February 1, 2006. Bernanke was confirmed for a second term as Chairman on January 28, 2010, after being nominated by President Barack Obama.
Bernanke is fascinated by the economic and political causes of the Great Depression, on which he’s had published numerous academic journal articles. Before Bernanke’s work, the dominant monetarist theory of the Great Depression was Milton Friedman’s view that it had been largely caused by the Federal Reserve’s having reduced the money supply. In a speech on Milton Friedman’s ninetieth birthday (November 8, 2002), Bernanke said, “Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna [Schwartz, Friedman’s coauthor]: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”
Bernanke has cited Milton Friedman and Anna Schwartz in his decision to lower interest rates to zero. Anna Schwartz however is highly critical of Bernanke and wrote an opinion piece in the New York Times advising Obama against his reappointment to Chair of Federal Reserve. In her opinion Bernanke appeared less focused on the role of the Federal Reserve, and more on the role of private banks and financial institutions.
Bernanke believed that the financial disruptions of 1930–33 reduced the efficiency of the credit allocation process; and that the resulting higher cost and reduced availability of credit acted to depress aggregate demand, identifying an effect he called “the financial accelerator”. When faced with a mild downturn, banks are likely to significantly cut back lending and other risky ventures. This further hurts the economy, creating a vicious cycle and potentially turning a mild recession into a major depression.
In 2002, following coverage of concerns about deflation in the business news, Bernanke gave a speech about the topic. In that speech, he mentioned that the government in a fiat money system owns the physical means of creating money. Control of the means of production for money implies that the government can always avoid deflation by simply issuing more money. He said “The U.S. government has a technology, called a printing press (or today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at no cost.” (He referred to a statement made by Milton Friedman about using a “helicopter drop” of money into the economy to fight deflation.)
Bernanke’s critics have since referred to him as “Helicopter Ben” or to his “helicopter printing press.” In a footnote to his speech, Bernanke noted that “people know that inflation erodes the real value of the government’s debt and, therefore, that it is in the interest of the government to create some inflation.”
For example, while Greenspan publicly supported President Clinton’s deficit reduction plan and the Bush tax cuts, Bernanke, when questioned about taxation policy, said that it was none of his business, his exclusive remit being monetary policy, and said that fiscal policy and wider society related issues were what politicians were for and got elected for.
Bernanke favours reducing the U.S. budget deficit, particularly by reforming the Social Security and Medicare entitlement programs. During a speech delivered on April 7, 2010, he warned that the U.S. must soon develop a “credible” plan to address the pending funding crisis faced by “entitlement programs such as Social Security and Medicare” or “in the longer run we will have neither financial stability nor healthy economic growth.”
Bernanke said that formulation of such a plan would help the economy now, even if actual implementation of the plan might have to wait until the economic outlook improves. Bernanke also pointed out that deficit reduction will necessarily consist of either raising taxes, cutting entitlement payments and other government spending, or some combination of both.
Hyperinflation, is it a hot air balloon theory that needs popping?
In the aftermath of the financial collapse of 2008, the US government spent, lent, or guaranteed up to $29 trillion to save Wall Street. The record increase in bank reserves was created as the Fed lent reserves, purchased toxic waste assets, and bought Treasuries from banks.
Most of this occurred during QE1 and QE2, as the Fed pursued a “quantity target” (increasing reserves) rather than simply a “price target” (low interest rate) to stimulate the economy. It didn’t work. Now QE3 seems inevitable but the jury is still out on whether or not, in simplistic terms, QE ‘works. However, by any chosen metric the banks have a couple of trillion dollar reserves they don’t need.
The ‘hyper-inflationistas’ worry is that if banks lend out those reserves, borrowers will pump up the economy causing inflation. Banks can lend a multiple of the reserves, fractional reserve banking, rather than lending $2 trillion, they could lend $20 trillion+ adding trillions to the USA GDP of circa $15 trillion, beyond the capacity to actually produce goods and services. All that would be added to the Federal government’s record budget deficit and borrowing. In short a debt-fuelled spending bubble would be the result, leading to the USA becoming the next Zimbabwe or Weimar republic.
However, that scenario and theory is critically flawed. Banks don’t lend reserves, there is no balance sheet operation that allows banks to lend reserves to anyone except to another bank that has an account at the Fed. The reason is quite simple: reserves are an entry on the balance sheet of the Fed. When a bank lends reserves, the Fed debits that bank’s account and credits another bank’s account. Banks lend their own IOUs, banks create demand deposits when they make loans; they do not lend reserves.
Reserves can, however, disappear if and when banks buy Treasuries from the Fed or from the Treasury, “paying for Treasuries” using reserves. Except for cash withdrawals or purchases of Treasuries, reserves stay locked up at the Fed.
The belief in hyperinflation relies on the contention that banks are willing to increase lending when they hold demand deposits as opposed to time deposits, they lend neither. They use reserves (demand deposits) for clearing with other banks, and for such day to day activities as ATM withdrawals. But Treasuries (“time deposits”) serve just equally well, banks can borrow reserves from other banks or the Fed, using Treasuries as collateral or other assets.
Banks don’t need reserves or Treasuries to lend, they lend their own IOUs. If they need reserves for clearing, or to meet required reserve ratios, they borrow them from other banks or from the Fed (discount window), or they sell assets to obtain them.
No inflation pressure on the horizon
Other than the speculative boom in commodities there are no significant inflation pressures in the USA economy. Up to twenty million Americans are looking for jobs, unemployment will be a permanent scar on the USA economy for years. At the current rate of very weak “recovery” the USA will not get back to the employment levels of January 2008 before 2017-2020 assuming that recovery doesn’t de-rail.
Recent data for the US shows a “double-dip” recession could be underway. A resumption of the financial crisis looks inevitable. Where are all those borrowers who are willing and just as importantly able to borrow the $2 trillion or $20 trillion to cause rampant inflation? The US private sector has ramped up their meagre net savings, they’re not borrowing, or spending their shrinking income. They’re behaving rationally by tightening their belts and paying off personal and corporate debt, therefore the prospects for inflation have not been smaller in living memory.
The prospect of hyper-inflation is about as close to zero as you could get, it’s as close to a bet that Bernanke will keep rates at ZIRP, (his zero interest rate policy) until 2014, which he stated yesterday as being as sure as a cheque you could take to the bank..that’d be a fractional reserve bank in control of its ‘fiat’ currency.