Flow of Funds

Here is a little graphic I did to explain why commodity prices are going up and why what the Fed is doing will only end in tears. It ends when citizens start pulling their deposits from good banks (to invest in commodities and inflating assets), which ends up dividing the good banks from the bad and forces the Fed to raise interest rates. We're not there yet. We need lots more inflation first. Don't worry. We'll get it.

The Fed is giving cash to bad banks in exchange for their bad loans (a repo). The bad banks need to earn their way out of this situation to pay back the repo, so they invest in inflating investments (commodities and foreign stocks).

Meanwhile, the government, to alleviate a loss of income by citizens, provides assistance. The government does so by issuing debt. To keep interest rates from going up, the Fed monetizes the government debt (the banks first buy the debt and then the Fed buys the debt from the banks for cash via the Fed Funds market). Rather than pulling back on spending, consumers continue to send cash overseas as a result of government-assisted overconsumption.

Foreigners are getting cash from both U.S. banks (via investment) and U.S. consumers (via continued overconsumption). The foreigners are wealthier and buy more commodities. As you can see, there is a lot of cash going into commodities.

The system breaks down when the citizens begin to see that this commodity inflation is a persistent state, and they begin to pull their deposits from good and bad banks alike, in order to invest in commodities. Who wants to earn 2% in a CD in one year, when you can make that in one day investing in oil?

Banks become divided, with some wanting higher rates to stop the flight of depositors and others wanting lower rates in order to get more assistance from the Fed.