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Inflation frozen in banks

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Saturday, Sept. 1, 2012, 8:57 p.m.

Most Americans worry about another recession. Little attention is paid to inflation.

Even America's central bank, the Federal Reserve, appeared to hold that view. To help stimulate the economy and reduce interest rates, it purchased $1.6 trillion of Treasury securities, and about $1 trillion of mortgage-backed securities to protect the housing market.

Most of the money it spent was created out of thin air and now sits on the Fed's books as debt, to be paid off at some point in the future, presumably when the economy improves.

Normally, the Fed's actions would prove highly inflationary.

Inflation occurs when there are excessive amounts of cash circulating in the economy and it falls in value. Under those conditions, it is best to borrow and invest in real assets. In a recession, cash is short and rises in value. Asset prices then fall and debts become increasingly onerous.

According to, the inflation rate in July was only 1.41 percent, down from 3.87 percent last September.

So where is the expected inflation? The excess cash created by the Fed, the potential driver of inflation, lies in bank deposits — not the economy.

Fearing a recession and more unemployment, consumers correctly are paying off debts and hoarding cash — mainly in bank deposits — despite negative real yields on their money.

Corporations, seeing great uncertainty and few signs of increasing consumer spending, are cutting costs, scrapping expansion plans and hoarding cash, at negative yields.

The major banks have become so flush with cash deposits that some now charge penalties for deposits in excess of $100,000.

With the Fed forcing longer-term interest rates down, bank profit margins are falling, which makes anything but the highest quality loans unjustifiable.

Furthermore, the Fed now pays interest on reserve deposits that banks keep with the Fed, meaning there is even less incentive for banks to risk expanded lending. The result is that loans to new businesses, which create the bulk of new jobs, continues to be greatly subdued.

Therefore, most of the stimulus dollars created by the Fed that has been thrown into the economy has flowed into the banks. It is not until it is used or leveraged up and lent by banks that it enters the money supply to create inflation.

Today, inflation quite literally is sitting in the banks. Meanwhile, to stop another recession from developing, the Fed is working to stimulate the economy further.

It continues to squeeze interest rates to record lows, offering negative rates, net of inflation, to all savers. This maneuver is designed to force money out of bank deposits and into the economy.

On Friday, in a much anticipated speech at a conference in Jackson Hole, Wyo., Fed Chairman Ben Bernanke defended this strategy and said he is ready to do even more.

Many observers expect the Fed to announce a further round of money creation, or quantitative easing, to purchase Treasury debt in order to lower interest rates further to reflate the economy. Wall Street and the world markets responded positively Friday.

But Bernanke's problem is that economic morale is low. Synthetic money created by the Fed increasingly ends up back in bank deposits, continuing a cycle that creates little economic growth while adding to latent inflation.

John Browne, a financial analyst and former member of Britain's Parliament, is a financial and economics columnist for Trib Total Media.

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