Last week, hedge funds sold off their bullion holdings in what was a monumental run to the exits. As the price of silver and gold trended higher against declines in other commodities, equities, and so-called risk assets, the price for bullion gave institutional investors the comfort they needed to boost cash.

But how much has changed since hedge funds eased up on margin plays in commodities?

Not all that much. In the past 12 months, central banks have become increasingly concerned about deflation, realizing that no matter how much cash is injected into the money supply, there are still plenty of people on Main Street unwilling to leverage up. Of course, any deflation is temporary; to assume that deflation is not temporary is to assume that borrowers will not, no matter how clean their balance sheets, go back to spending.

Consumers have an appetite to spend, just not an appetite to borrow to finance this spending. In a world dominated by fractional reserve banking, this is a temporary concern for inflation-protected asset classes.

Measuring the Growth of Credit

In the second quarter of 2011, American consumers added some $18.4 billion worth of debt to revolving accounts—credit cards. This addition was a 66% increase to the amount added to plastic in the same quarter of 2010. It was also 368% more than consumers added to their liabilities column in 2009. Despite the belief that deflation is certain, it appears that consumers are far more comfortable adding debt now than they were even 2 years ago, a sign that declining money supply as measured with credit included may continue to run higher.

What has central bankers concerned isn’t American’s willingness to use plastic—credit cards merely make loans of M2 money supply; they do not turn M0 reserves into M1 money—but American’s concern with installment debt for college tuition, cars, and homes.

In one year, Americans have increased their borrowing through installment vehicles by a collective 1.5%, a rate which, less the cost of money, is still negative. In order to make sure that newly injected cash does reach the economy, central bankers around the world have to be sure that borrowers come back to borrow for the long haul.

The Next Wave

Ultimately, the markets will find equilibrium, bad debt will be pushed from the system—or inflated away—and Main Street will begin to force M0 reserves into the traditional money supply.

Silver investors should know that such a change in inflation is not one that is transitory, but rather an immediate reaction. When the market reaches equilibrium, a wave of borrowing will happen almost immediately. There is no stopping a flood of credit of this magnitude. Central banks, especially the Federal Reserve, would have to entice banks to keep assets in reserve. The Fed can enact such a policy only by agreeing to pay a higher rate on reserves held at the Fed, which would only compound the growth in money supply.