derryl

Impending Inflation? The Global 'New Deal' All but Guarantees It

L-Bow:
There are only 3 ways money can be created in the first place.
1. A bank makes a new loan which creates a new deposit in the borrower's account, which the borrower spends into the economy.
2. A bank sells a security to the Fed in exchange for Federal Reserve notes ("cash") or a credit in the bank's Fed account. Banks hold the cash to satisfy their depositors' cash withdrawal demands.
3. The federal governments sells securities to the Fed and the Fed credits the government's account, and the government spends the money into the economy.

Each of these actions (except banks holding money in their Fed account) increases the M1 circulating money supply. The point is, this is all the "money" there is.

When a borrower repays a loan the deposit (which had circulated around the economy until the borrower collected it back to repay the loan) ceases to exist and the money supply is reduced by that amount. When the government redeems its security from the Fed with money it collected by taxing the money it spent into the economy back out of the economy, that money ceases to exist.

L-Bow asks, "Who will borrow all the money that is printed to reinflate the economy?" If the government borrows money from the Fed to pay for infrastructure projects or more rounds of "stimulus" checks, that's one way to do it. Then don't tax it out of the economy until after a general recovery has occurred. This will not be inflationary because a lot of people will use the new income to pay down their personal debts and that debt-money will cease to exist.

If the government borrows money to buy up mortgages and other distressed assets, the banks who made the mortgages will reabsorb the loan money and it will cease to exist, so this is not inflationary. Actually this is deflationary, because the money supply decreases by the amount of the repaid mortgages.

Banks are at or near technical insolvency not necessarily because their cash reserves are too low, but because their capital value has dropped so much when bank share prices fell along with the rest of the stock market. Banks have a legislated upper limit of assets (loans) to capital (common and preferred shares and long term debentures they hold). I think the ratio is 20 to 1 but that might be outdated. By selling assets like mortgages to gov't they can get their ratio back in line with their reduced capital value. The government owes money to the Fed, but this debt can be treated as an accounting nicety and ignored as long as it is expedient to do so.

Banks don't "have to" fail, even if they are in technical default. The decision is up to the Comptroller of the Currency. It is in nobody's interest to destroy the US banking system so banks are being helped out of this hole.

I think the private sector will be pretty shy of new borrowing for awhile so I don't think there will be any inflation happening unless the federal government decides to inflate away US foreign debt. Paulson's $700 billion will just restore bank's balance sheets by reducing their assets to a level in line with their reduced capital. That money will never circulate.

But the original borrowers of that $700 billion spent it into the economy. The people who sold things to the borrowers still have that money (if they lost it, someone else has it). So there's a lot of "owned" money in the economy: the people who now own the money are not the people who owe that money to the banks. That money is sitting it out waiting to see what happens. Eventually it will get invested and spent, and the gov't can start taxing to collect the money to repay the Fed. It would take some working out, but the thing could be fixed in this way.