Mortgage and Foreclosure Law Blog

Part II: Remember the Credit Crisis? Banks are required to hold a certain amount of cash in there reserves. Back in 2007 and 2008 banks were constrained from lending money by their reserve requirements. Now with all the money infused into bank's reserves the lending has begun and will continue over the next few years. Why? That's what banks do, they increase their liabilities in the hopes of increasing their quantity of money over time.

The faster the banks make these loans, the faster the quantity of money in circulation grows. With the credit crisis all but over and an increased trust in the banking system demand for money has and will continue to dwindle. This will be exasperated by higher unemployment and lower spending overall in the economy as well. Reduced demand for money with a rapid growth in the money supply results in inflation and high interest rates. The higher interest rates will further reduce the demand for money and result in greater inflation. The cycle strangles itself.

The solution for this problem would be for the Fed to reduce the money supply. In order to do this they would have to sell bonds. Unfortunately this would put the Fed in competition for selling bonds with the Treasury. This competition would result in failed auctions and lower bond prices. This isn't going to happen. That is why you should plan now for high interest and inflation, it is coming.

Howdy Readers. In today's two part series I'd like to begin to explain, what I believe to be a very difficult topic. That task is to explain why the Federal Reserve Bank's huge infusion of money into the banking system will end up causing double digit inflation and interest rates, not unlike the seventies.

In September 2008 the Federal Reserve began a phase to drastically increase the monetary base. The monetary base is made up of currency in circulation, member bank reserves held at the Fed, and vault cash. They increased the monetary base by almost $1 trillion. This percentage increase is the largest in the past 50 years by a factor of 10!

The currency-in-circulation component of the monetary base (which, prior to the expansion was 95% of the monetary base) has risen by a little less than 10%, while the bank reserves have increased almost 20 fold. Now the currency-in-circulation component of the monetary base is less than 50% of the whole thing.

This means that bank are holding huge reserves of money. What do banks do with this money? They find way to lend it. Tune in tomorrow and I'll explain why the huge reserves the bank will be lending out over the next two years will cause skyrocketing interest rates and inflation.