Where's the Money - Robert Murphy Comments

Economist Robert Murphy tackles, in this post, the conundrum of a massive increase in the money supply by the Fed, but only small signs of inflation so far. If you recall I also tackled this here and linked to Louis Woodhill's article on it here.

Dr. Murphy ascribes some of the same causes as I have. Namely, that some of the new money supply is being held at the Federal Reserve and not being loaned out.

...as you can see, the increase in reserves is basically just sitting in the (electronic) vaults on the Fed's ledger. Even though banks have the legal ability to make new loans to customers (which would increase M1, M2, MZM, etc. by more than the base itself increased), they aren't doing so

He does not mention Woodhill's observation that the Federal Reserve is now, for the first time, paying interest on these deposits, allowing banks to pick up a spread by keeping deposits into checking accounts and standard savings account at the Fed instead of loaning them out.

However, he does go on to outline some disconcerting implications about these reserves:

What happens when the panic in the financial sector subsides, and banks feel comfortable lending again? Well, loosely speaking, it means that the amount of money in the hands of the public (as opposed to reserves that commercial banks have on deposit with the Fed) can increase the same percentage as reserves have increased.
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Now obviously Bernanke is not going to sit back and let prices go up by a factor of 14. But how does he suck reserves out of the system? Why, he has to sell off the trillions in new assets that the Fed has recently acquired. And of course, this is precisely all of the "troubled" assets that nobody wanted to hold in the first place, and that had caused the major players to seize up.

And even if Bernanke decides to hang on to all of the mortgage derivatives--you know, the ones that are going to make us taxpayers so much profit in the coming years--and he just dumps U.S. Treasurys, guess what that does? It lowers the price of Treasury debt, meaning interest rates rise.

This will run up against some serious political problems.

1) The Obama administration plans to borrow massively, driving up interest rates. (If you believe in Keynesian stimulus the economy should grow nevertheless)
2) The economy is predicted to still be recovering from recession.

How exactly does the Fed justify driving up interest rates, and slowing the economy, in a recession? The actions needed to stem this massive inflationary pressure may not be politically feasible. Yikes.

He supports buying gold:

I hope my advice to acquire physical gold and silver makes more sense now.