The banks don’t have to lend to inflate

Contrary to popular belief, banks do not need to lend to expand the money supply and eventually create price inflation. Yes, the Australian banks are still lending at an impressive rate but since the bust this has been predominantly to the housing, individual and public sectors, with commercial lending actually declining year-on-year (although it is already on the way back up from July lows).

Just because the demand for loans by businesses fell off does not mean that the monetary pumping undertaken by the RBA will have no effect on price inflation. Banks never have to be passive and, indeed, they usually waste no time in spending their new cash reserves. All they have to do to expand the money supply is buy existing securities, whether from each other or other corporations, thereby increasing deposits. They do not have to depend upon business firms to request commercial loans, or to float new bond issues.

…But it doesn’t matter anyway

Saying that, in a speech today the RBA's head of domestic markets department, John Broadbent, revealed that “…listed corporates have raised a record amount of equity this year, totalling some $60 billion, with issues broadly based across all sectors.” So not only are banks buying existing securities but they are buying up new bonds at record levels. This will be inflationary.

Mr Broadbent continued to say that most of these equity raisings had been used to pay down debt, with some companies explicitly saying the funds raised were to repay bank loans. While this may sound deflationary, it is not.  When someone pays back debt, the money used to pay that debt with does not suddenly disappear but simply goes to the creditor, in the case the bank. The bank then spends on additional security purchases, shares, or issues more loans which increase deposits. In other words, most if not all of the ‘repaid debt’ flows straight back into the economy.

The seeds have been sown

“The first sign of a hyperinflation is a rally in the stock market,” Jens O. Parrson, Dying of Money: A History of the Great German and American Inflations.

The new money and all-time low interest rates from the RBA coupled with a record fiscal deficit and added public debt obligations has created a new wave of malinvestments (investment in areas not aligned with consumer preferences but that which appears profitable thanks to the artificially low cost of credit and rising prices) in Australia that will eventually need to be liquidated. As an example of the rising confidence, the latest Dun & Bradstreet business expectations survey of 1200 business owners and executives shows expectations for investing in capital are at the highest level in 10 quarters, registering an index level of eight points. It is only a matter of time before the distortions created by all of the new cash created by the banks – and enabled by the RBA – will be revealed. While it may take a few years thanks to factors such as China’s demand for Australian resources, foreign accumulation of the Australian dollar (as bad as it was, every other nation appears to be inflating more) and so on, those same factors will mean the eventual bust will be worse in Australia than elsewhere.

The Australian recovery is not sustainable and rapid price inflation is a very distinct possibility.