When the Federal Reserve Bank (the fed), which is the nation’s central bank, purchased $3.7 trillion of government and private debt in the period 2008-2014 in response to the Great Recession, I thought hyperinflation was sure to follow.  I said as much in my letters and conversations with clients.  I was not alone.  As far as I could tell everyone in the financial press and the markets thought inflation was about to erupt.  Always had in the past, but this time it didn’t happen.  Why not?

I recently found an answer in an article in the Wall Street Journal (May 29, 2020, Sect A, p.15) by Phil Gramm and Michael Solon entitled “Why the Fed may not duck inflation this time.”  Messieurs Gramm and Solon offer this explanation.  Following a new piece of legislation (Dodd-Frank Act of 2010) the fed required banks to park their excess reserves with the fed, paying them handsomely to do so (the latter was the new twist: to pay banks for parking their excess reserves with the fed; up to then bank reserves were not compensated ).  The fed then borrowed $3.7 trillion from this pot of excess bank reserves and bought as much in private and public debt, driving down interest rates, driving up bond prices and generally sustaining these markets.  The important point which I and everyone else missed was where the $3.7 trillion came from.  The fed had not printed it, as was generally assumed, but rather had borrowed it from the banks.  In doing so the fed created liquidity but did not create money, as I and everyone else had thought.

So that’s what happened, or at least I think it is what happened.  This would explain why inflation did not take off: the government was not printing money.  And, therefore, the thesis still holds: print money and there will be inflation.  A lot more can be said.  And a lot will be in subsequent submissions.  But let me close with this modest observation.  It is a problem when no one understands what “the experts” at the fed are doing with our money.  Missing is transparency.  The term is perhaps overused in this time, but no where else is it more important than it is with money and credit.

 

Mark O’Brien

June 8, 2020