Stage 7 – Quantitative Easing Broadly Inflates Prices

Stage 7

The next stage of America‘s Financial Endgame™ will occur when the quantitative easing by the Federal Reserve spills over and broadly inflates prices.  This is a seminal step in the end game scenario, because it signals one of the important “turning points” where the actions being taken by the government become extremely difficult to reverse.

In the case of our current financial situation, broad price inflation is being held back by a lack of growth in private bank lending.  (In contrast to rapid expansion of government debt and quantitative easing by the Federal Reserve)  The result of this private contraction / government expansion has been a very slow increase in the rate of growth for total credit.

Thus, we see that the key to this avalanche is private lending.  Given the trajectory of terminal government deficits, it stands to reason that the key factor standing between our current financial situation and broad price inflation is increased lending on the part of banks.  When compounded by the fact that banks are currently holding approximately $1.4 Trillion in “excess” reserves beyond what is required to secure their loans, the danger becomes clear.

Stage 7a

This danger stems from the fact that banks can create new loans at a 10:1 ratio versus their reserves.  In practical terms, this means that banks can create $14 Trillion in new loans with the current excess reserves alone.  This is enough to increase the total credit outstanding by nearly 30%.  It would not take long for a credit increase of this magnitude to spill over into broad price increases.

However, the Federal Reserve is keenly aware of these risks and has elected to pay banks interest on their excess reserves.  The purpose of this policy is to hold back the tide of inflation that will ensue if all banks simultaneously use their excess reserves to create new loans.  While this end is accomplished, it comes at the “literally” paying banks to not make loans.

Another attribute of the current financial system is the near-zero rate of interest that the Federal Reserve offers to banks.  One of the things banks use this capital for is the purchase of Treasuries that pay a yield in excess of what must be paid to the Fed.  This has the result of suppressing the interest rate on Treasury notes, and suppressing mortgage rates by extension.Stage 7b

The unfortunate situation that has evolved is one where the government is dependent on permanently low interest rates to finance the perpetually increasing national debt.  If interest rates regressed upward toward historical averages, it would explode the annual interest expense liability of the US government, and displace many other forms of spending that are more politically desirable.

Thus, the (all but certain) result will be an indefinite continuation of the current policy to sustain artificially low interest rates, and suppress the expansion of private credit with artificially low Bank borrowing rates from the Fed.  The domestic political regime in Congress and the Executive Branch have used the strategy of influencing votes with promises for government programs.  This makes it quite infeasible for public policy to rapidly turn in a long-term sustainable direction, since the platform of the current political power structure is intentionally oriented toward continued spending that continues to grow indefinitely.

In this way, we can expect to see more and more quantitative easing until inflation suddenly explodes into another financial crisis.  We can expect to continue seeing near-zero interest rates until investors become unwilling to hold US bonds, and a price collapse spikes yields.  All of these things will continue in perpetuity until the “breaking point” is ultimately reached and the actions spill over into broad, widespread inflation.

In the next chapter, we will explore the likely impact of this broad inflation.

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