Comment by nick-dap | Hacker News Reader

Comment by nick-dap | Hacker News Reader

A couple of weeks ago a friend pointed me to a blog entry about the coming inflation since the Fed supposedly printed vast quantities of new money. The blog entry felt very religious in proving someone defined as "deflationists" wrong, so I didn't think much of it.

I am very much interested in open government data so I wondered how much of the financial data is actually available from the Fed in its raw form.

It started as me wondering how full of shit this guys is and turned into five to six hours of trying to understand the raw data that is readily available from the Fed online. Their website is surprisingly good.

What I saw did not make me happy. The Feds actions resulted in an EXPONENTIAL increase in monetary base of our economy: http://en.wikipedia.org/wiki/Monetary_base Note that all I did is plot the numbers that the Fed supplies: http://img180.imageshack.us/img180/2792/44768686.png

It seems that all those "bad mortgages" that the Fed bought were not bought with "debt." The Fed bought them with freshly printed bills. Go on the Fed's website and download the data for yourself, don't take my word for it. Regardless, I dismissed my findings as "I don't actually know what I'm doing" and forgot about it.

This article however is absolutely in line with what I saw happening from the raw economic data, so it makes me wonder. We _did_ print exponentially more money than we have ever done before. Look http://img180.imageshack.us/img180/2792/44768686.png The Fed literally DOUBLED the amount of money in our monetary base in a matter of months. I can't imagine the Fed being able to take that much money out of circulation in nothing less than years. I also can't image how that could not be a very bad thing.

Another thing that I saw is a rather sharp increase in how much banks are keeping in reserves since the Fed now guarantees interest on reserves. http://www.federalreserve.gov/newsevents/press/monetary/2008...

All this money in reserves has nowhere to go but into the economy once banks start spending it. It also pisses me off that our banks were essentially given a lot of money (when you see a doubling of money in the economy, thats a lot) for them to sit on and for us to pay interest on it!

I am failing to understand the Feds plan. Can anyone enlighten me or is it really this simple?

I think the concern is justified. However, considering Japan during the 90s and the Great Depression makes deflation appear much more dangerous and persistent than inflation because no one knows how to fight it once it's become entrenched.

We know how to fight inflation. Interest rates can be raised without limit. They cannot fall without limit. The Fed can sell the bonds they are now buying back into the market and thus reduce money supply.

And you need to consider two other facts. First, the monetary base you plotted is just a small fraction of overall money supply (M1, M2, M3). Other parts of the money supply are growing as well but not as fast. Second, money that isn't used has no effect on inflation. The speed of circulation is sharply reduced in recessionary times and that's why the amount of money has to be sharply increased to counteract that potential deflationary spiral.

The line you want to plot is the amount of all monies (the Ms) normalized over the speed of circulation. That line is flat to falling, but it's true that there is a potential for a sharp rise down the road.

Inflation is very likely in say two years time. It's very difficult, politically, to raise interest rates while unemployment is still high. And inflating debt away is rather convenient for a heavily indebted nation like the US as well.

The Fed has made politically difficult decisions in the past. During the 80's, they kept interest rates high, despite the massive unemployment.

They certainly did not make politically difficult decisions over the last decade, which would have been to cool off the growth. They generally only make these difficult decisions in hard times, not good times.

no one knows how to fight [deflation] once it's become entrenched.

Personally I agree with this, but remember FED Chairman "Helicopter Ben" Bernanke's oft-repeated quip that the FED has (metaphorically) a printing press and can whip up however many dollars are needed to prevent deflation. So in theory, the US has the right man in the right place for this very problem.

I don't see a whole lot of success yet. With all the layoffs and offshoring it's not clear additional dollars are the right approach -- wait, I take that back. It would be a great help if there were more early-stage Googles to employ people to make others more productive. If only there were some way to encourage talented people to start new companies...the US needs a Startup Czar!

The Fed loans money to banks. Their unorthodox response to the financial crisis involved (1) creating new lending mechanisms allowing loans to be rolled over for longer periods of time, and (2) accepting illiquid securities as collateral instead of just things like Treasury Bonds.

But these are still short-term loans measured in months not years, and they are still taking collateral for them. Which makes it trivial for the Fed to shrink the money supply by however much it wants pretty much whenever it wants. It just stops rolling over the loans and takes the cash out of circulation as the banks give it back.

It is always possible that some banks will default on repayment and collapse. But that scenario isn't consistent with inflation because any significant collapse would be deflationary. And in a deflationary environment you want to be expanding the money supply.

Simply put, what the Fed giveth the Fed can taketh away. Be grateful Bernanke is a grown up, and that political posturing on the debt issue isn't keeping policy makers from preventing this thing from becoming a lot worse. The policy response is pretty good, especially when considered in light of how much worse this could easily have been:

http://delong.typepad.com/sdj/2009/09/i-see-one-third-of-a-g...

>>Which makes it trivial for the Fed to shrink the money supply

It will be very hard politically.

>>and they are still taking collateral for them.

Real estate that has collapsed in value

>>The policy response is pretty good, especially when considered in light of how much worse this could easily have been

How do you know? Supposed it collapsed: stocks, houses all dropped. Maybe that was the natural order of things.

My thought on the supposed worse case scenario if there were no bailouts: #1 We have plenty of houses, commercial retail space, etc. So no one would have gone homeless. #2 The midwest is still the breadbasket to the world. We wouldn't go hungry. #3 Banks would have gotten a good lesson in respecting risk. In 5 years from now they'll be taking new risks that are just as stupid as the ones they took today because they know they will get bailed out.

> Real estate that has collapsed in value

The value of the collateral is meaningless. Either there is inflation or not. If there is no inflation the increase in the money supply is good because it prevents deflation. If there is inflation you're out of a liquidity trap and there is no need for these special measures.

> How do you know?

Not me. We. Regression analyses on the relationship between employment and inflation/deflation levels are measurable and can be calculated with robust large scale data sets. This is called the Phillip's Curve:

http://en.wikipedia.org/wiki/Phillips_curve

Japan engaged in quantitative easing for a decade and never had inflation.

Just because they print money doesn't mean it goes into circulation. It's currently sitting in bank vaults, and the increase reserve requirements agreed by the G20 will also ensure that much of it will have to stay there due to liquidity requirements.

Also, be wary of anything by Ambrose Evan Pritchard - he is always writing these alarmist, breathless articles saying that the world is going to end. Read some of his other articles to get some context.

Japan engaged in quantitative easing for a decade and never had inflation.

Correct. Instead they had the "Lost Decade" of economic stagnation, as it is known there (and here). It's actually been much longer than a decade now (it started in the early nineties). A few weeks ago it cost the governing party, which has been in power for 53 of the last 54 years, control of the government.

Money follows the law of supply and demand as much as anything else. When the supply of it (relative to the supply of goods and services) goes up, the price (value) of it goes down: inflation. So one of two things has to happen: either the Fed lets that money stay in circulation, triggering a boom in the short term followed by inflation in the long term, or they start sopping it up and "burning" it, which will trigger a downturn.

Think about it this way: if all we had to do was to trun on the printing presses to make economic magic happen, why wouldn't we do it all the time? Inflation is the worst form of taxation, because it causes such massive economic distortion, as we've recently seen in the housing market. The Fed pumped up the money supply and people watched their home's valuation go up 10% or more a year. They then made bad economic decisions based on the false idea that it was real. And now we have the current mess.

I agree. However, your leaving out a large part of the debt structure. Well, you point to it a bit "They then made bad economic decisions based on the false idea that it was real". If it were only values of homes that dropped, it wouldn't be so bad as those assets are still valuable in that they are standing homes and can be used without regard to their value. There is a much larger debt bubble of more "perishable" product in wide ranging industries (supply chain, international investment, etc) some of which originated based on real estate value.

The Fed has clearly staked out its path. Nowhere to go now but to continue down it.

Bernanke and crew said the financial problems were limited to Subprime loans. They were very wrong. Now they are saying they will be able to manage inflation by soaking up all that new money when the economy gets better.

Do you believe them?

nope, I don't believe them. If the debt bubble were limited to subprime loans, its a big correction to take on, but we could get through it...real estate would be cheap for a couple of decades; cool, there is actually some value in that. If the liabilities truly were limited to house values dropping, it would be almost trivial to calculate the bank's liabilities. Banks have no idea what's on their balance sheets, because houses are the tip of their debt iceberg.

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