The Fed's Creative Self-Destruction

Van Hoisington and Lacy Hunt have figured out what few others have; namely, that excessive debt and falling asset prices have conspired to render the best efforts of the Federal Reserve impotent.

Please consider the Hoisington Second Quarter 2009 Outlook.
 

“One of the more common beliefs about the operation of the US economy is that a massive increase in the Fed’s balance sheet will automatically lead to a quick and substantial rise in inflation. [However] An inflationary surge of this type must work either through the banking system or through non-bank institutions that act like banks which are often called 'shadow banks.' The process toward inflation in both cases is a necessary increasing cycle of borrowing and lending. As of today, that private market mechanism has been acting as a brake on the normal functioning of the monetary engine.

Foreclosures and delinquencies on mortgages are continuing to rise, indicating that the banks and their non-bank competitors face additional pressures to re-trench, not expand. Thus far in this unusual business cycle, excessive debt and falling asset prices have conspired to render the best efforts of the Fed impotent.”

With that, we can safely add Hoisington to the small group of people who understand that Belief In Wizards Is Misguided. Continuing with a discussion from Hoisington:

The Complex Monetary Chain
 

“[I]n economic parlance, for an increase in the Fed’s balance sheet to boost the price level, the following conditions must be met:

1. The money multiplier must be flat or rising;

2. The velocity of money must be flat or rising; and

3. The AS or supply curve must be upward sloping.

“The economy and price changes are moving downward because none of these conditions are currently being met; nor, in our judgment, are they likely to be met in the foreseeable future.”

Note that lower velocity doesn't cause anything to happen. Lower velocity is a result of increasing demand for money (i.e. a reluctance by consumers to borrow, and banks to lend).

Reluctance to lend can easily be seen in a chart of bank reserves,