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Will the Fed's aggressive expansionary measures lead to hyperinflation?

  • Yes (74%, 223 Votes)
  • No (26%, 80 Votes)

Total Voters: 303

The Federal Reserve has tripled the monetary base over the last four years and inflation remains below two percent. Despite the Fed’s money pumping, hyperinflation is not afoot.

For an analysis of how allayed inflationary fears will lead to a more robust real estate recovery, see the upcoming October issue. 

Hyperinflation, meet the Boogie Man

Since trends in real estate prices and sales volume are in fact lagging indicators of the greater economy’s vitals, it is essential to look at leading indicators and economic drivers in order to prognosticate the real estate market’s expected growth or continued decline.

Today, in the U.S. economy of fiat money, the prime economic driver is the Federal Reserve (the Fed), their control over interest rates and, by extension, the money supply. While the well-informed know the true measure of the economy’s recovery is increased employment, the panicked masses only hear one word whenever the Fed’s role in fixing the economy is mentioned — inflation.

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Back to basics: inflation 101

Beyond the basics: asset price inflation in the real estate market

The Fed can take one of two positions when it comes to its monetary policy and management of the economy: expansionary or contractionary. To date, the economy still languishes in the Lesser Depression for lack of demand for new employees, reflected in part by the still deeply troubled real estate market. In order to put people back to work, the Fed has continuously taken expansionary measures, an effort to stimulate lending and private demand for new employees and equipment.

They do this in fulfillment of the dual mandate held by all central bankers to create full employment and price stability; with inflation currently on target, near 2 percent, the latter half of their mandate is under control. However, with nationwide unemployment still at an economically debilitating 8 percent as of August 2012, the Fed’s duty to create an environment conducive to full employment has yet to come to fruition in this economic epoch. That, at last, is about to be changed by the Fed.

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Monetary policy since the onset of the crisis from the Federal Reserve

Reeling from California’s lack of jobs

Nothing is structurally wrong, as many have worried; there is simply a lack of private demand. In our capitalistic arrangement, this lack of demand triggers the government’s responsibility (Congress or the Fed) to correct by spending until full recovery is achieved.

Nothing is structurally wrong, as many have worried; there is simply a lack of private demand.

With the Fed’s recent announcement of QE3, Ben Bernanke and company have vowed to pump and pump until the economy is sufficiently stimulated into a period of real and positive growth when they can pull back and allow it to steam ahead — a defibrillating shock to the economy’s hibernating heart. The Fed has been loath to act due to political rhetoric and fear mongering, which has resulted in the public’s unfortunate and irrational fear of hyperinflation — that is, until now. QE3 will work, and it will do so without resulting in hyperinflation.

We are here to tell you, dear readers, that just like the Boogie Man, hyperinflation is only under your bed as long as you firmly believe in it.

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New York Times: Still a phantom menace

The Fed pays interest

We have written several articles explaining why quantitative easing and the rest of the Fed’s deployed expansionary arsenal will not lead to hyperinflation. There are a number of reasons why this is so — the broad stroke is that the Fed has as much control, if not more, over contracting the economy as it does expanding it (see lessons from Paul Volcker in the late ’70s/early ‘80s, which took place for entirely different inflationary reasons than today’s).

But lately one key piece of willfully disregarded information regarding the Fed’s ability to stem inflation has become more visible to the public. We can only speculate that this information has been kept close to the Fed’s vest for fear of public reproach ­— a politically motivated silence on their part for which there can be no excuse, as inaction has destroyed livelihoods and standards of living for many in all age groups and most occupations forever.

But due to the inflationary fear mongers (inflation hawks, as they are known), the Fed has begun publishing economic letters explaining exactly why hyperinflation has not and cannot take root in the foreseeable future regardless of how much money they print since we are at zero-bounded interest rates. This is the liquidity trap from which interest rates can only rise, a completely opposite condition from 30 years ago and the intervening years of dropping rates which propped-up asset prices and created artificial demand after previous recessions.

Mainly as a response to the recession of the early 2000s in the wake of the dot com crash, The Financial Services Regulatory Relief Act of 2006 was signed into law by President Bush. You read correctly, this was a major legislative maneuver of banking de-regulation instituted at the height of the real estate bubble and just as the financial crisis was brewing. Ironically, what seemed a boon for the banks in fact gave more regulatory power to the politically independent Fed.

At the center of the act was a provision allowing the Fed to pay interest on required and excess bank reserves. Banks that borrow cash from the Fed (all the Big Banks that matter) must meet a mandated reserve requirement. If the Fed takes expansionary measures, such as they are today, as lenders amass huge stockpiles of cash, these excess reserves are deposited with the Fed along with their required reserves. Until 2006, the Fed paid no interest on these reserves, thus it was argued by the Big Banks that the mandate of a reserve requirement was tantamount to a tax imposed on the banks, that their reserve cash wilted on the Fed’s shelves, gnawed upon daily by the rat of inflation and romanced away by the math of opportunity cost.

In 2006, the Fed was slated to begin paying interest on cash reserves by October 1, 2011. However, after the financial crisis of 2008, Congress acted swiftly with the Emergency Economic Stabilization Act and revised the effective date to October 1, 2008. Thus, the Fed has been paying banks interest on their reserves, required and excess, for nearly four years — an unprecedented shift in U.S. financial and monetary policy.

Related article:

Federal Reserve: Interest on Required Reserve Balances and Excess Balances FAQs

The money multiplier is dead

In the history of U.S. monetary policy extending all the way up to 2008, the Fed had to battle the banks’ opportunity cost of keeping excess reserves on deposit. Before the Fed paid interest on reserves, lenders holding excess cash would quickly seek qualified borrowers to lend the cash to in order to charge interest and realize a return.

Lenders with excess reserves bearing no interest were motivated to invest and thus introduce cash into circulation via consumer lending, leading to a classic money multiplier effect, which would eventually result in inflation if not controlled by the Fed. Here’s how the money multiplier works:

    • lenders have extra cash on deposit at the Fed;
    • they are induced to lend it in order to make a profit;
    • creditworthy consumers borrow these funds and ultimately spend/exchange them for goods and services in the economy;
    • upon exchange of the funds by borrowers, the cash is again deposited at a commercial bank by those who receive them when they sell goods and services;
    • this deposit is added to the bank’s already existing excess reserves;
    • the bank is further induced to lend these funds in order to profit;
    • the cycle continues, eventually leading to too much money in circulation chasing too few goods; thus
    • inflation occurs;
    • at which point the Fed must intervene by increasing interest rates private banks charge to lend funds.
QE3 is upon us; hyperinflation is not.

This is the classic monetarist narrative of how inflation occurs. Of course, as the Fed has pointed out in its recent economic letter, it no longer holds. This monetarist model is now ancient history.

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Monetary policy, money and inflation from the FRBSF Economic Letter

QE3 is upon us; hyperinflation is not. Make no mistake — a modicum of inflation will occur above the Fed’s two percent target, as it needs to in order for demand to ramp up. Although interest rates will fall in the near future as a result of the Fed’s actions, the long-term effects will cause rates to rise — and rise they will over the next 10 to 15 years. That means a lengthy period of falling real estate prices.

That’s right; as the economy gains steam, asset prices will fall. But this fall is only back to their historical mean price — where real estate ought to be for its long-term health.