Still Worried About All Those Reserves?

Many commentators still seem to be screaming that hyper-inflation is around the corner. The crux of their argument is that the Fed has pumped hundreds of billions into bank reserves. There is a chart circulating, which you may have seen, illustrating this explosion of credit. After all, reserves normally translate directly into fresh lending. I have reproduced the chart for you here:

It is a scary chart, I admit. The inflation fear-mongers forget several things though. First and foremost, reserves don't become part of the money supply until loans are actually made from those reserves. So how are we doing on that front? Well, the Fed reported consumer credit yesterday and it was dismal despite "cash for clunkers". Total consumer credit fell, again, and has contracted some 4.6% since its peak. For the record, it hasn't declined more than 1.8% from any peak since WWII. Take a look:

Might those reserves be lent to businesses instead? Well, here is a chart of total loans and investments at commercial banks- in other words, this is lending to businesses:

No loan growth there either. This makes perfect sense when you stop to think about it. All banks care about (or should care about) is how likely they are to have their loans repaid. Aside from credit bubbles when banks act like drunken sailors, that is all they need to figure out. In an economy this bad, the most credit worthy borrowers don't want more debt, nor do they need it. The less credit worthy are too risky, so less lending takes place. On the business side, what business is eagerly borrowing to finance expansion? When consumers are clearly retrenching, global trade is slowing and massive uncertainty about growth prospects remain, who is going to borrow in order to expand? Companies are in survival mode and are using cash flow to maintain their business or even shrink it. Without demand for loans from credit worthy borrowers, lots of new loans are not going to be made.

This scenario is what a develeraging cycle is all about. It is by its very nature deflationary. As I have written about before, deflation is your worst enemy. Those screaming about inflation seem to ignore this dynamic. It is also this very deleveraging cycle which helps cause velocity to fall. For everyone's sake, you better hope the Fed can create some inflation before serious deflation takes hold.