The toughest part of responding to this post is knowing where to begin. It’s probably best to start at the top and work down.
As low-interest rates give incentives to people to borrow money this increases the amount of money in existence, that’s the definition of inflation. If rates increases and then people stop borrowing, less money is in circulation, so then we have deflation.
The simple quantity of money is not inflationary, or deflationary, with a floating exchange rate fiat currency. It is always the availability of resources the currency is deployed to purchase that determines prices. Even if one commodity becomes scarce and its price increases the increase will not be across the board with all commodities unless increases in the currency supply are sudden or far in excess of available labor and resources. Gold standard logic may be comfortable in its simplicity but is erroneous with a fiat currency and floating exchange.
In a loan of U$1,000,000, that would mean the banks only pay U$2,500 in interest per year. Pretty cheap huh?
It’s actually much cheaper than that. The Fed rate only applies to interbank transfers as the banks attempt to balance obligations and reserves (which are the obligations) to legal standards of compliance. However, it doesn’t mean that a loan made to a borrower has that overhead. Banks create reserves when they lend and always balance those to the net principal of the loan.
They don’t lend from existing savings/reserves and haven’t since ’34 when domestic convertibility to gold ended, along with fractional reserve banking. The reserve level of the bank is never a concern in determining whether or not to loan to a qualified borrower. In the reversed world of banking, a loan is an asset and the reserves created are obligations. Since only public money (high power) can retire private debt, paying off a private sector debt reduces the overall money supply as your payment will balance the bank’s reserves to zero.
In 2008, the central banks lowered interest rates as much as they could. But that wasn’t enough to keep market afloat. So they engaged in a program called “Quantitative easing”, where they provide liquidity for the markets.
The Fed understands money, and they knew that adding liquidity wouldn’t increase lending for banks that don’t lend from reserves. QE was a covert move to soak up more risky bonds that Goldman-Sachs and others still had on the books. It ended up back in bonds, but the secure brand that Treasury offers. The Fed returns its profits to Treasury where they are deleted from the system, so it was easy to discount the questionable bonds and take the hit.
One important fact we need to remember, all this printing is possible because we are in a fiat system, so the central banks can just print the money. Money is only based on faith.
That is somewhat true. However, the faith in question is the faith in the government’s ability to levy and collect taxes, not in a unit of measure. As long as taxes are denominated in the US dollar and America accepts no debt in any other denomination it can never fail to pay any obligation also denominated in dollars. This is exactly why the US dollar is the preferred store of value in the world, as it is never “needed” to enable the government to spend and will always pay what is promised.
We got into that situation because of the US broke the promise on the Breton woods gold standard.
We never failed to exchange any gold for any other sovereign, but Nixon saw the writing on the wall for the gold standard in a net importing nation. Remaining in the agreement would have drained our gold reserve and weakened our position globally. The gold standard was an archaic method of trade that greatly limited the use of our own resources and our economy.
Now with interest rates so low, central banks don’t have space to manoeuvre, it is likely we are going through a financial reset, where a new reserve currency will likely emerge. Some central banks have been accumulating gold since 2008 (Like Russia and China), that could hint we are going back to gold standard.
Lots of nations do quite well without the reserve currency of trade, and so will we if that happens. The incentive for this won’t be the amount of money we print though. It will be our propensity to sanction other nations at the drop of a hat as a foreign policy. No one wants their trade procedes threatened with lockdown by a global bully. It is our unholy alliance with the Saudis that makes the arrangement necessary for oil importers, and one can’t blame them for resenting that. We will definitely invade Venezuela if we can’t effect regime change as it has the necessary reserves to challenge the Saudis in setting prices. It only lacks refinery capacity, which China and Russia would gladly provide to break the US/Saudi monopoly.
The indicators of a recession or even depression are pilling up, we need to be aware of what can possibly come our way and hedge it accordingly.
Agreed. As long as our leadership so profoundly misunderstands the process of our monetary system and thinks it can cut and gut its way to prosperity we are at extreme risk. Every dollar spent by the government that isn’t recovered via taxation becomes someone’s asset in the private sector, not a “debt” that has to be repaid. America is still resource-rich and can “afford” anything that is priced in dollars that Congress can create at will. If we realize this reality of fiat currency we “might” avoid much suffering by backstopping the people instead of the banks. We should be moving toward a federally funded job guarantee now before it is needed. Then the banks can’t do the damage they did in ’08.
