Public Credit Expansion Fuels Inflation

posted by Nima

April 23, 2011 · Posted in General Economics 

Are the current price increases we see across the board inflation? Well, price increases are never in themselves inflation, but they can be signs of inflation.

Inflation, as I have explained before, is an increase in the supply of money and credit.

Let’s see what’s been happening in the US over the past year.

Total Loans and Leases:

Total Loans and Leases still had their peak in 2008. In early 2010 there was a big spike and they have been declining since then.

Total Bank Credit at Commercial Banks:

A similar pattern can be observed with Total Bank Credit ad Commercial banks as you can see above.

Together those two numbers give you a pretty good and complete indication as to how private credit has contracted in the in US and still continues to contract from peak credit.

However, the most complete picture of credit in the US is, as always, a number in the Fed’s Flow of Funds Report “Total Credit Market Debt Owed”:

Here we can see that indeed through 2010 there has been a resurgence in credit, in spite of a contraction in private credit. The reason is that public credit, that is money owed by governments, has soared:

total-credit-04-24-2011

Yes, we have been back in inflation mode indeed, but without the private sector playing along on a long term basis, I don’t think that this one can last very long. All that this has done is fuel speculation and bubbles again in commodities, junk bonds, and stocks. A few jobs may have been created as a result of that, a few more may get created. However, these developments are completely unsustainable. Government intervention in the past crisis has ensured that this will be a long, ongoing, and painful period, and we are witnessing it right now.

We are now in a desperate repetition of what I already warned about in 2007 when I wrote “Credit Expansion Policy“:

The policy of credit expansion has been pursued by governments time and time again. It has become prevalent in the United States under President Woodrow Wilson after the establishment of the Federal Reserve Bank under the Federal Reserve Act during the Christmas Holiday of December 1913. Since then, it has caused major credit booms and crunches in the form of asset booms and subsequent crashes and economic booms and subsequent recessions. In particular this has been the case in the years of 1929, 1987, and 2001, and will be visible in 2008 and the following years. It has always precipitated precisely the effects outlined above. Its workings and effects have been fully explained by this theory of the business cycles. No one has ever refuted the correctness of this theory.

Yet, to date economists and politicians appear completely riddled as to what causes booms and crashes. It is claimed to still be a matter of discussion amongst experts. It has been attempted to impute it upon humans’ greedy nature and natural exuberance. Whenever a crisis emerges the pundits, experts, central banks and politicians will try and regulate the market to stave off the impending crunch. They forget or don’t have the intellectual capacity to understand that it has been their own policy that has caused the crisis in the first place.

As long as the central banks keep pursuing this policy, there is no need to be surprised when the next credit crunch occurs. Neither is there any need to be surprised about the fact that all countermeasures taken by the government will turn out to be utter failures that will accomplish nothing but aggravate the crisis. For if the cause of the problem has been too much government intervention, then more government intervention will only add to it.

The only difference now is that private sector credit is not playing along anymore. In fact, private sector credit is doing precisely what it should be doing: contract.

When the next crash comes, I expect that we’ll be back in deflation mode again in no time at all, snapping back into the long term pattern of this contraction. Like I said before:

Thus the long term outlook for the US economy is the fate Japan took: A long lasting correction supercycle with one failing “stimulus” program after another, and with on and off periods where the economy slips out of and back into recessions from time to time.

And most importantly … when the next crash comes, I sure hope people will point their finger at the root causes, and not at whatever lying politicians and media minions will tell them to.

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