Monetary Policy and the Shadow Banking System

Is current monetary policy inflationary? This seems a reasonable expectation in light of the fact that the Federal Government and Federal Reserve are injecting all together about $4 trillion of paper money into the economy.  Nevertheless many economists believe that the ultimate result may be deflation because of the destruction of the Shadow Banking System. How is this possible? What is the “Shadow Banking System”  and why should it be so important?

Over the last ten years ingenious new forms of investment have been devised to protect investors against excessive risk in the market. These include such things as  “credit default swaps,”  “remics” and “ABSs”,  known all together as “derivatives.” It is estimated that there are over $50 trillion worth of these instruments in the market, creating a great deal of liquidity.  But within the last six months this liquidity has been destroyed.  A major cause, though perhaps not the only cause,  has been the mark-to-market rule. The result is that the entire global economy is short of cash and credit.  From this perpective the money being injected into the economy may not cause inflation — or then again it may, after all, depending…

Ulrich Kortsch has been involved in international finance for many years.  His experience in over 50 countries has ranged from running a securitization company in Peru to developing a microfinance enterprise in Ghana to consulting for Toyota.  A supporter of free markets, he has special knowledge of the world of derivatives and similar instruments that have played such a key role in the present crisis. He is also an unusually good speaker, able to convey his ideas clearly as well as vigorously.

Read his article Inflation or Deflation?