Tuesday, November 16, 2010

Will the Fed’s $600 billion cause hyperinflation?

Many think  that the Federal Reserve’s sudden creation of $600 billion will cause hyper-inflation.  However, when calculating the relative “inflationary” value of the new $600 billion compared to the huge dollar value that was created by the housing bubble, the Fed’s amount is very small in comparison.

Here’s the calculation:
Using census data one can make some ballpark calculations of the effective size of the liquidity created by the housing bubble.  Eighty million single family homes exist in the US and had an average value of $171K in 1997.  In 2007 the average value had gone up to $310K. This increase in value in 10 years meant an average increase of $13.9K per year for every house . That translates to an increase in total house values  (detached single family houses only) from $13.6 trillion in 1997 to $24.8 trillion in 2007. This represented an increase of $11.2 trillion dollars over 10 years.  And since it was easy to sell a house during most of that time or get a second mortgage on a house, this $11.2 trillion was largely available for people to spend.

Since 2007,  housing experts have estimated that housing prices nationally have fallen about 25% from their peak in 2007. That drop represents a  functional drop in liquidity of $6.2 trillion dollars in three years which is over 10 times the amount of the Federal Reserve’s instant $600 billion injection. And with the new higher lending standards and many people (as many as 50% in some States) underwater on their mortgages , the trend looks like it will continue to be strongly deflationary.  

If the instant currency creation by The Federal Reserve becomes routine, then the people claiming hyper inflation is coming will ultimately be right. If it is a onetime event, the $600 billion is not enough to ignite hyper-inflation by itself.

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