A reader recently forwarded a Twitter message to me from famed economist Lindsay Lohan, in which Lohan expressed her fear that “the U.S. dollar will soon be worthless if the Fed keeps printing money.” My first thought was to wonder who on earth follows both Jerry Webman and Lindsay Lohan, but since at least one person does, and because Ms. Lohan’s comment contains just enough economic reality to be confusing, I thought I better address the issue.
As visitors to this site will recall, my economics studies followed the curriculum of the orthodox monetarists of the “Chicago school.” I even enjoyed a few dorm cafeteria dinners with Milton Friedman, so I know that “inflation is always and everywhere a monetary phenomenon,” and that “inflation is too much money chasing too few goods.” Since I also know that the Fed has used its power to print (actually to generate electronic blips that represent) $600 billion in new money over the past nine months, I can see why someone might worry about the future value of the buck. Should you? I think you should pay attention to what’s going on, but not to worry—at least not yet.
When the Fed increases the money supply (the “quantity” in “quantitative easing”), it credits commercial banks with a sum of newly created money in exchange for an equivalent value in securities—usually U.S. Treasury paper. The new money shows up in the commercial banks’ reserve accounts with the Fed and stays there until the individual banks lend it to customers. The money that banks lend then circulates through the economy “chasing goods,” while the money in the reserve accounts just sits there (and collects 0.25% interest). Although over the past year bankers have reported a greater volume of commercial and industrial loans, most of the new money is still sitting in the reserve accounts. In fact, bank reserves held at the Fed are about $600 billion greater than they were before quantitative easing began last fall. While I’m convinced that quantitative easing did prompt some investors to shift from Treasuries to riskier investments (such as stocks), the facts simply don’t justify the idea that all that money is out there pushing up the price of the things we buy.
Could that all change? Yes, and investors need to watch for eventual laxness in monetary policy, but for now, Ms. Lohan needs to find a new target to blame.