Monday, February 16, 2009

The benefits of oligarchies

Why hasn't the huge amount of money pumped into the economy caused inflation? It hasn't caused inflation because the money is sitting in bank vaults. It is not circulating, so it effectively does not exist. If it were released into the economy, inflation would spike dramatically.

It makes sense, therefore, for bankers to sit on the money. When inflation happens, those who own currency-equivalent assets take the greatest hit. That is just about a perfect definition of a bank. The banks have the strongest incentive to hold down inflation. If all the major players agree that the temporary benefit of being the first to release the new funds is overshadowed by having their balance sheet inflated away, they'll sit on the money forever.

Ironically, the foreclosure crisis is making it less necessary for banks to fight devaluation--they're swapping currency-equivalents for real estate every time there's a foreclosure. The more assets they have and the less money, the less harmful a devaluation will be.

The banks are stopping the government from devaluing the currency, which to me is an entirely unexpected negative feedback loop.

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