Hyperinflation in America? Naw, can't happen.

How could the U.S. government fall into the economic fallacy that a country can simply print its way out of any problem? In a traditional banking system there are borrowers and savers. The bank acts as the middle-man that facilitates transactions between the two. To attract new capital the bank offers a savings rate that is given to anyone who stores their excess money with that particular bank. In turn, the bank then lends out that saved capital to the borrowers, with a slightly higher interest rate to cover its own expenses and make a small profit.  Not exactly rocket science. Please note though, a traditional bank can only lend out as much money as it can attract from savers on the open and free market. The minute a bank starts acting irrational with other people’s money those individuals will withdraw their funds and move to a more reputable bank, or risk losing it. Now let’s throw in the Federal Reserve’s form of moral hazard.

Under the pretense of “stimulating economic growth” the Federal Reserve allows banks to legally practice what is known as fractional reserve banking. With this practice a bank is given a reserve ratio on which it can lend on. For example, let’s say a bank is allowed a reserve ratio of 10:1, and has $100 in reserve (saved). Legally that bank can then lend out $900 on the original $100.  This newly created $900 is then sent out into the world, where it can, in due time, also be saved and thus create even more new money. A legalized triangle scheme if you will. So one can see how inflationary this practice really is. This practice is very lucrative for the banks involved. Talk about a money tree, these banks are literally creating money out of thin air, and profiting from it legally. How does this practice affect the banks when they no longer have to attract savers through good banking practices? 

Then I read this article which reveals a trend that can only lead to economic suicide. Right now for every $1.00 in reserve the lending bank can then issue $202.00 of new money to borrowers. (Note: During the “Roaring Twenties” the reserve ratio was around 12:1 at its peek.) This new money is created because the Federal Reserve controls the reserve ratio allowed at each bank. Throw in the artificially low interest rates, which the Fed also manipulates, and this crisis, as well as previous recessions are understandable. 

Artificially low interest rates make money cheaper to borrow, so basic economics tells us that demand will subsequently increase. This only exacerbates the fractional reserve issue. This new money then trickles into every segment of the economy, from real estate, to small business; it even serves to artificially inflate the stock market i.e. what is occurring now with the help of the stimulus money. So until this new money, which has (or did until the bust occured) created an artificial supply of goods to match the increased artificial demand for goods, is liquidated and removed, we can expect to continue down the current path toward hyperinflation. 

But hyperinflation can not happen in America ... U.S. Treasury Secretary Timothy Geithner said so. I'm not holding my breath.