PhillyDeals: Forecast: Inflation, rates rise as credit eases

As the Federal Reserve creates more money, why aren't banks lending any?

The Fed pumped more than $1 trillion into troubled financial companies back in 2008 to keep them from failing as risky home loans went bad, loan financiers failed, and credit markets froze.

That got the system past the crisis. Last spring, the banks started repaying that money, with interest.

Did the Fed shrink back to normal size? No, it stepped up massive buys of U.S. Treasury debt, "driven by a need to fund the government's deficit," as veteran banking analyst Richard X. Bove, of Rochdale Securities, of Stamford, Conn., put it in a report to clients yesterday.

The Fed also bought piles of government-backed home-loan bonds to help crippled Fannie Mae and Freddie Mac after it took them over.

Result: The Fed's assets have kept rising, and are now at "all-time high levels" of $2.3 trillion, up from less than $1 trillion two years ago, by Bove's count.

Normally, when a government creates too much money, the laws of supply and demand come right into play.

Too many dollars means each dollar is worth less. Prices go up. Interest rates spike. You get inflation.

But that's not happening yet, Bove told me. That's because banks aren't lending out that money. They're keeping it in their vaults, and at the Fed, to cover bad loans and stricter new government capital guidelines.

Federal regulators shut two or three banks each week last year, and plan more closings this year. Lenders are being told to act conservative. So as "loans are being repaid, the money is not being re-loaned."

This won't last. "When bank lending returns, as it is likely to do by the end of this year," the result will be more money on the street, "higher inflation, and higher interest rates," for loans and for business and government debt, Bove concludes.

Bove is optimistic, says Joseph Harenza, chairman of Griffin Holdings Group L.L.C., a King of Prussia- and Reading-based investment bank that specializes in financial companies.

Banks still face massive losses on office buildings and other commercial real estate. Consumers are too busy coping with shrunken paychecks, home equity and retirement savings to borrow. "The banks are essentially shrinking," Harenza told me. He doesn't think lending will recover until 2012 or later.

Just one in five wireless-using Americans has a BlackBerry, iPhone, Droid, or other Internet-enabled smartphone, writes Janney Capital Markets analyst David Strasser.

But with video, Internet, and phone services converging in these devices, and giants such as Google, Dell and Microsoft pushing sales, "we expect to see a strong upgrade cycle in 2010" at Best Buy, RadioShack, and other store chains.

Why not just buy your smartphone online?

That's the only way, at present, to buy Google's Nexus One. But for some other smartphones, manufacturers and software providers don't like easy price-shopping and the resultant price chopping.

So only "a limited number" of smartphones can be bought online. It's "an attempt by vendors to prevent consumers from researching online for the cheapest price," Strasser wrote.

Smartphone makers love the Internet - and want the government to make sure customers can access streaming movies and other fat files without limits, through Internet services such as Verizon and Comcast.

But not if it costs manufacturers or their allies: "I think that they will try and keep some high-end products from being sold online, as a way to help their retailers from having people do all the research at a retailer, then go home and buy online," Strasser told me.

Just back from last week's Consumer Electronics Show in Las Vegas, Strasser is not impressed by the "desperate" hype over 3D video.

For all the fuss over Avatar-style jump-at-you shows making the leap to TV and online, 3D is "at best a special-occasion product," offering select recorded shows, not live events, according to Strasser.

And yet: Fancy 3D demos will herd shoppers into stores and will likely boost sales for what "will inevitably prove to be the most profitable product in the 3D profit cycle" - those nerdy 3D glasses.