The Fed's Anti-Recession Effort May Unleash 15% Inflation

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Investors Business Daily:

The annual inflation rate in the United States could hit 15% by late 2013 or early 2014, and the Federal Reserve may be powerless to stop it.

While much can change the risk of inflation, the single most important driver of a rise in the general price level is the relationship of the money supply to economic activity.

Since the economic meltdown began in 2008, the Fed has pumped an unprecedented amount of money into bank reserves. In 2011 alone, adjusted bank reserves increased at a compounded annual rate of 47.1%. As these bank reserves filter into the business and consumer economy, the risk of inflation rises.

Until recently, the reserves weren't going anywhere. The banking industry was taken to task for making risky loans before the economic meltdown. So they were happy to sit pat.

What's more, in October 2008 the Fed started paying interest on reserves held at the Federal Reserve Banks. Apparently designed to help buoy bank balance sheets, this made it profitable for banks to forgo lending in favor of the low-risk profit provided by the Fed's interest payments.

Banks are currently holding about 15 times more than the roughly $100 billion in reserves required by the Fed, or $1.5 trillion. Historically, banks — which make profits primarily by lending out money, not keeping it — have held only 1% or 2% over required reserves.

Even at the current lending rate, the money supply has been growing faster than the economy. In December 2011, M2 — the money supply measure that includes currency, checking accounts, savings accounts, money-market mutual funds, and traveler's checks — grew at a year-to-year rate of about 10%. The U.S. economy during this period grew at 2.8%.