Comment: Interest rates are not the primary drivers of inflation

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Interest rates are not the primary drivers of inflation

Although interest rates and inflation rates are closely linked it is important to remember that most of the money creation that happens in our economy is NOT through rate manipulation by the fed but INSTEAD through the fractional reserve banking system.

I've heard many people say how the banks got all this money for free and now they are not lending to anyone. This, in my view, deviates slightly from what is really happening. Right now the majority of people are not looking to increase their debt but reduce it. Its not that banks are not lending. It's that people are not borrowing.

The reason Ron Paul understands why QE will fail (as well as every other austrian economist) is that he understands that economics is not running on a thermostat that you can set or adjust. Economics is about people and where they are in their lives. After such intense increases in debt throughout the last 20 years people are tired of borrowing money. This means that number one driver of monetary expansion has been cut off at its core (Most people currently deciding policy are more worried about deflation which is what setting interest rates at 0 indicates).

The Fed is now down to its last resource in its fight against deflation. It has (relatively) recently begun to print money and directly purchase treasury bonds as well and mortgage backed securities (MBS). This has only been happening in the last couple of years. Take a look in contrast to the amount of debt people have incurred over the last 10-12yrs:

-Private debt (institutional debt and consumer debt) went from $20T in the year 2000 to $42T in 2012 (a $22T increase in a little over a decade!)
-Unfunded liabilities are conservatively estimated at $60T
-Finally government debt has risen by over $10T

Since 2009 the Fed's balance sheet has been expanded by about $3T. Right now they are far from having monetized the amounts of debt incurred since the beginning of this generational bubble. We have already been through a period of heavy inflation and now all the debts are coming due. If borrowing money is equivalent to creating money than paying back a loan is equivalent to destroying money. Because this situation is chronic not only throughout the US but also throughout the world we are being subjected to intense deflationary pressures which are a result of past interference with interest rates.

Remember that hyper-inflation is not a guarantee and you should not make all of your plans depend on this one specific senario. If the Fed shuts down tomorrow you can be sure you will not see hyper-inflation happen. Instead you will see a depression of the money supply like none other making each dollar more and more valuable as they circulate less and less (not that this would be a bad thing in the long run. The market is indicating that we have overextended and need to pull back).

The schools of thought surrounding the future of monetary policy at the current moment is speculative. We are basing our projections on what we have experienced in the past. It is natural to assume that the Fed will always print money but they too are subject to outside pressures. If we listen to many people calling for hyper-inflation we always hear them say that the QEs will continue to fail and they are right. But what if one day the Fed stops easing? What sort of event would cause them to do this?

If there is one thing to remember through all this is that the Fed is always behind the curb. Like Ron Paul said "We are always fighting the last battle."