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The inflation bomb and Charles Darwin
Federal Reserve Chairman Ben Bernanke will tell Congress this week how the Fed plans to diffuse the $1 trillion bomb ticking away inside the banks. Did I mention that the Fed assembled this bomb in the first place?
I am, of course, referring to the $1 trillion the Fed created out of nothing and pumped into the banking system the past two years. That money is sitting on bank balance sheets as "excess reserves." If all that money was injected into the economy in the form of loans, inflation would explode, and the dollar would quickly be worthless.
But the Fed has a plan. Under a law passed in the 2008, the Fed can pay banks interest on those excess reserves -- whatever rate it wishes. According to the Wall Street Journal, the Fed intends to jack up that interest rate so banks have no incentive to lend it:
...looking ahead to when the economy is strong enough to warrant tightening credit, officials have been discussing for months which financial levers to pull, when to start and how best to communicate their intent.
When the Fed is ready to tap the brakes, it plans to raise the rate paid on excess reserves, according to Fed officials in interviews and recent speeches. The higher rate would entice banks to tie up money they otherwise might lend to customers or other banks.
Looking ahead to when the economy is strong enough to warrant tightening credit. I'm sorry, I must have missed something. When was credit loosened? The only entity banks have been lending to is the government.
So the Fed created all of this money and poured it into the banking system with the expectation that banks would eventually lend it to businesses again. Instead, the banks kept the money, tightened credit and found ways to make money off of it without lending it to business. Oops.
And now that the money's out there, the Fed's strategy is to prevent banks from lending it at all costs. If it floods the economy, inflation will go sky-high. When in this equation do businesses actually get access to credit? Here's an excellent description of what's going on here from Goldseek:
One could liken this situation to that of a loaded revolver... In essence, the Federal Reserve dealt with those mischievous risk-takers at the banks who had nearly destroyed the financial world by handing to them a loaded revolver that was pressed against the heads of all the nation's savers, investors and retirees. A revolver that could destroy most of the value of your personal savings. Then the Fed said "Please don't pull the trigger! We will create however much money is needed and pay it into your personal bonus pools, just so you won't pull the trigger on that revolver we just handed to you."
The American people and the economy are the hostages, and the banks have the gun. Now, they can say to the Fed: Hey, we want 10% interest on these reserves, or the public gets it! No, wait a minute, make that 20%! More from Clusterstock:
Of course, in the process of increasing interest paid on reserves, the Fed will be paying banks even more not to lend. In the process, it will be giving banks yet another way to take nearly free money from the taxpayer and give it back to the government at a higher rate--and then pocket the difference.
All of this underscores the main message of the government's bailout policies, which has been so glaringly evident over the past year: It's a great time to be a banker.
In the meantime, businesses that can't get access to credit continue to fail. You could argue this is some sort of Darwinian event for the economy, that only the strongest businesses should survive.
But Darwin's theory sure doesn't seem to apply to the banks.
Good post. It gives the lie to the claim that bailing out the TGTF financial companies and politically connected banksters was done to benefit the rest of us. The government has provided about $13 trillion in guarantees, loans and gifts to them (e.g., to Goldman Sachs).
Nomi Prins site provides an accounting of the money.
http://www.nomiprins.com/bailout.html
There is also the issue of how the worthless assets the Fed accepted as collateral onto its balance sheet as well as those still held by banks will affect the real economy. They don’t just disappear.
No analysis of the effects on the broader economy had the TBTF financial institutions not been bailed out has been provided. So far all we get are hyperbole and one liners. As the recession drags on the government will claim that it cannot afford FDR like policies and programs to help the rest of us in the real economy and prevent further TBTF driven economic problems.
So Fed is going to subtract money by addition. As the addition (interest on reserves) increases money further, they will keep adding more money to subtract and so on it goes forever. Am i making sense or is it some kind of new magic.
2. Does anybody know what part of new money printed by FED went to bank reserves compared how much ended as new govt debt? My guess is most of the new money ended up as federal govt debt.
Scott -
I'm afraid I missed something too! How is it the Fed can wield this much unrestrained power?
What was Bernanke's goal in this scheme? Clearly, it doesn't seem to be working - and it's creating more risk - not less.
Finally, what if a majority of American families were to boycot their neighborhood big bank? What would likely occur? Would there emerge a new incentive for the Fed to intervene again?
It seems to me that the banks had the gun to our heads even before the government steped in. In a way, they stopped the trigger from being pulled by giving out more bullets. Not ideal.
@Jim. The problem with actually hurting the banks is that they still have the gun to our heads. Right now, we are damed if they fail, and we keep loosing the longer we prop them up.
What we really need is bankrupcy reform. Remember the crux of this whole problem is that if one big chunk fails, it takes the rest of the sytem down with it. We need bankrupcy laws that can prevent that domino effect. I'm not sure what they would look like, but I'd be interested to hear some ideas.
Well, since nobody listened to me last time when I warned everyone, here's a new approach to stop the TBTF banks. All of you, PLEASE move your cash out of the TBTF banks and into credit unions until the banks feel and listen to US! Without US they cannot survive, it is as simple as that. They do not have the upperhand, WE do. All you need to do is this simple act. If ALL of US do this we can bring them to their knees!
