The truth is out: money is just an IOU, and the banks are rolling in it

[freedom]

You have to understand that the money which causes inflation is mostly money created by the commercial banks, so called M2. Though the central has stepped up to create trillions of narrow money(bank reserves, so called MB, mostly circulating among commercial banks, limited outside circulation by withdrawal of physical notes), the commercial banks have not stepped up to create more deposits or issue more loans.

So it really does not matter for the sake of inflation how many rounds of QE the Fed does. What it matters is how much money the commercial banks create. Based on current Basel III regulatory requirements, there isn't going to be a lot of money to be created by the commercial banks.

So how is there going to be hyperinflation if there isn't more money around?

[specuvestor]

The article is mostly right, but it is just another side of the same coin. If you analyse banking sector, you would have a rough idea how it works. There is of course the CAR ratio which is to make sure you have a sufficient equity buffer. Then there is the bank reserve which makes sure that every $ of deposit you have, a certain % goes to buying safe treasuries. Singapore banks have Loan/Deposit ratio of about 80% so roughly every $1 deposited gives rise to 80cts loan. And indeed this 80 cts loan gets recycled back to the system to generate another 64cts loan. This is the multiplier effect, assuming everything is so mechanical. A change in the cost of money and Reserve ratio will have an impact on this multiplier, as well as the business environment and credit risk. This complex dynamics is well demonstrated in the GFC.

The 1st order impact of QE was to reduce the cost of money so much that people would invest but things are not so mechanical. On the demand side, businesses were unwilling to invest in a deteriorating business environment, those businesses looking to raise money was not for investment, but cash crunch ie lousy credit. In addition, if you recall the US banks were unwilling to lend when QE started... they rather put it into the bank reserve earning 0.5% than lend it out to businesses. Through this they actually indirectly bolstered their capital, which was why the Fed is furious that they wanted to pay dividends. It took a few QE for the credit enviroment to improve and bank lending re-started and the monetary multiplier resumed. There are quite a few variables involved and not just a simple press of the button kind of process, which inlcudes monetary, structural and policy changes.

What QE eventually achieved is to improve liquidity, reduce credit cost and lower cost of business. However too low a business cost distorts opportunity cost which is what Einhorn of Greenlight Capital is saying, and hence induce irrational risk taking and stifle innovation, when environment is deemed good of course.

As to why US did not experience significant inflation is because the US was firstly deflating due to GFC. Secondly the RMB was soft pegged to the US$ and they were exporting cheap goods. 3rdly the banks were not lending aggressively hence the multiplier effect was muted. The corollary is that all these 3 factors are not exactly true today, so we should be seeing US inflation rising, which can be partly mitigated with strengthening USD.

See this link for the discussion on fiat and reserves, and why USD is unique:
http://www.valuebuddies.com/thread-4576-...l#pid74637

[yourusualkid]

The article is mostly right, but it is just another side of the same coin. If you analyse banking sector, you would have a rough idea how it works. There is of course the CAR ratio which is to make sure you have a sufficient equity buffer. Then there is the bank reserve which makes sure that every $ of deposit you have, a certain % goes to buying safe treasuries. Singapore banks have Loan/Deposit ratio of about 80% so roughly every $1 deposited gives rise to 80cts loan. And indeed this 80 cts loan gets recycled back to the system to generate another 64cts loan. This is the multiplier effect, assuming everything is so mechanical. A change in the cost of money and Reserve ratio will have an impact on this multiplier, as well as the business environment and credit risk. This complex dynamics is well demonstrated in the GFC.

The 1st order impact of QE was to reduce the cost of money so much that people would invest but things are not so mechanical. On the demand side, businesses were unwilling to invest in a deteriorating business environment, those businesses looking to raise money was not for investment, but cash crunch ie lousy credit. In addition, if you recall the US banks were unwilling to lend when QE started... they rather put it into the bank reserve earning 0.5% than lend it out to businesses. Through this they actually indirectly bolstered their capital, which was why the Fed is furious that they wanted to pay dividends. It took a few QE for the credit enviroment to improve and bank lending re-started and the monetary multiplier resumed. There are quite a few variables involved and not just a simple press of the button kind of process, which inlcudes monetary, structural and policy changes.

What QE eventually achieved is to improve liquidity, reduce credit cost and lower cost of business. However too low a business cost distorts opportunity cost which is what Einhorn of Greenlight Capital is saying, and hence induce irrational risk taking and stifle innovation, when environment is deemed good of course.

As to why US did not experience significant inflation is because the US was firstly deflating due to GFC. Secondly the RMB was soft pegged to the US$ and they were exporting cheap goods. 3rdly the banks were not lending aggressively hence the multiplier effect was muted. The corollary is that all these 3 factors are not exactly true today, so we should be seeing US inflation rising, which can be partly mitigated with strengthening USD.

See this link for the discussion on fiat and reserves, and why USD is unique:
http://www.valuebuddies.com/thread-4576-...l#pid74637

Great stuff there, thanks for the reply.

[financiallyfree]

thanks freedom and specuvestor for the insights