These days, borrowing is hard, but money is easy. The stock of money continues to rise and is now making its way into commodity prices.
Concentration in the banking industry is one reason the credit crunch remains with us. Another is that a rapid increase in the money supply — a ‘loose’ monetary policy — distorts investor incentives.
Actions of the Federal Reserve have increased the monetary base by 51 percent since October of 2008. In the U.S. the monetary base consists of currency held by individuals and firms and bank reserves held locally or on deposit at the Fed. It is money that could be lent to businesses if there was an expectation of positive real, or inflation-adjusted, returns.
Between 2002 and 2004 interest rates were well below what the Taylor rule required and what some policymakers recommended, contributing to our problems today. The rule, named for John Taylor of Stanford University, says monetary policymakers should set the short-term interest rate in the banking system based on a target inflation rate and the gap between actual and trend gross domestic product. In an interview last week, Treasury Sectary Timothy Geithner conceded monetary policy was “too easy” then.
The Federal Reserve expanded the money supply from 2003 to 2005, leading to commodity and credit bubbles around the world. The greater-than-necessary quantity of dollars kept interest rates on mortgages and other long-term debt low.
Easy money remains with us today, but the incentive to lend does not exist. The very loose monetary policy in response to the crisis of this past year is showing up only in higher commodity prices.
On Tuesday, the Commerce Department reported that our deficit in international trade of goods and services increased to $27.58 billion in March from a revised $26.13 billion the previous month. The February deficit was originally reported at $25.97 billion.
By definition, a trade deficit is an excess of imports over exports. There are several factors that influence a country’s exports and imports, such as the tastes of consumers for domestic and foreign goods, the prices of goods at home and abroad, and the exchange rates at which people can use domestic currency to buy foreign currencies.
The increase in the U.S. trade deficit for both months was due in large part to higher imported oil prices. In the report, the average price per barrel of imported crude in March rose by more than 5 percent. Crude oil prices are up more than 50 percent since lows reached in February.
Oil prices are rising even as U.S. demand for gasoline is falling. According to the most recent data from the Energy Information Administration, gasoline consumption is down 7 percent from its high in 2005.
The recent rise in oil prices is due to investors pulling their money out of cash and short-term debt instruments and putting it into hard assets such as crude oil. There is little incentive to lend long-term when there is ample cash for asset purchases that can make good returns quickly.
Meanwhile, a broad indicator of inflation continues to rise. The yield-spread, or difference between the interest rate on 2-year and 10-year U.S. Treasury notes, has climbed above 2.2 percent. A positive spread suggests rising inflation and interest rates.
Because the Fed cannot control or perfectly predict investor and banker behavior, it cannot perfectly control the amount of money in the economy. To date, monetary policy has increased the money stock dramatically, but done little to spur real economic activity. All we have to show for it is strong inflationary expectations and increasing price volatility.
Since 2000, Peter R. Crabb has been a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.