Money Supply

In a simplistic view, the amount of the deficit is seen as increasing the amount of money in the system and therefore leading to inflation. This view is only true if the money theoretically created gets into circulation and is greater than the amount of money that leaves the system.

Money is created in part by banks making loans. Based on the reserve requirements, banks can lend more money than they have in deposits. The idea behind this is that they have enough in reserve to meet demand while increasing liquidity in the system.

What should not be forgotten is that a lot of money has left the system, based on increases in reserve requirements, the failure of both banks and private (shadow banks) lending organizations and the tighter credit requirements. Further, the value of one's assets represent money available to the system to the extent that the asset valuations exceed current debt. To have an increase in the money supply we would need more money created than has disappeared.

Considering how greatly asset valuations, particularly in home values, has fallen this represents a tremendous decrease in the money supply. As foreclosures have increased, the reserves to cover these foreclosures must be replaced or the total lending has to be decreased to maintain reserve requirements.

In 2008, about 11 trillion dollars of wealth was lost in the United States. This means an amount between 3-4 trillion dollars and 11 trillion dollars left the money supply depending on reserve requirements. The total deficit in no way is able to replace that amount of lost money.

There is less money in circulation than there was two years ago.