Skip to comments.Why There's No Real Inflation - Yet
Posted on 01/30/2013 11:35:47 AM PST by blam
Why There's No Real Inflation - Yet
Economics / InflationJan 30, 2013 - 01:16 PM GMT
By: Money Morning
Martin Hutchinson writes: According to Milton Friedman, "inflation is always and everywhere a monetary phenomenon."
If that is true, then you have to wonder where the heck all of the inflation is.
Every central bank in the Western world is holding interest rates down, and almost all of them are printing money like it's going out of style.
Five years ago, nearly every economist in the world would have told you this would cause inflation to skyrocket, and the big deficits governments were running would make matters even worse.
Taken together, monetary and fiscal policies are far more extreme than they have ever been.
Yet, inflation has remained rather tame at 2%. In Friedman's world that just wouldn't be possible.
What does it all mean?....
It means even Nobel Prize-winning economists can get it wrong-at least in the short run.
Here's why Friedman has been wrong on inflation so far. It starts with his basic theory.
Friedman's Theory on Inflation
The central equation of Friedman's monetary theory is M*V=P*Y, where M is the money supply, Y is Gross Domestic Product, P is the price level and V is the "velocity" of money, thought of intuitively as the speed at which money moves around the economy.
In this case, the M2 money supply has been increased by 11.5% in the last two months and 8.2% in the past year, while the St. Louis Fed's Money of Zero Maturity (the nearest we can get to the old M3) has increased by 13.1% in the last two months and 8.4% in the last year.
Since GDP is increasing at barely 2%, that ought to mean prices should increase by 6%, just based on the last year's data alone.
Needless to say, that's not happening, since consumer price inflation is under 2%.
Of course, monetarists will tell you that money supply produces inflation only with a lag.
Fine, but it's also true that the M2 money supply has been increasing by 7.4% over the last five years. Admittedly, there was a year in mid-2009-2010 when it stayed flat, but otherwise the monetary base has been increasing at about 8-10% per year.
Again, growth in those five years has been below 2%, and five years is longer than anyone thinks the lag should be. So why isn't inflation at least 5% not 2%?
Monetarists would explain that by telling you that monetary velocity has declined over the last five years.
That's obvious from the equation, but what is monetary velocity and why has it declined?
The velocity of money is simply the average frequency with which a unit of money is spent in a specific period of time. And in our day-to-day activities, it's obvious that monetary velocity has in fact increased.
More people are using debit cards, which cause transactions to move instantaneously from the bank account to the merchant, and many people are using Internet banking, which similarly increases the speed of transactions, reducing both the amount of physical cash carried and the time that old-fashioned checks spend sitting in storage at the U.S. Postal Service.
So what is the problem?
Monetarists will tell you that the decline in monetary velocity is due to the massive balances, over $1 trillion, which the banks have on deposit with the Fed, which just sit there and do nothing.
That's probably correct since while the deposits exist, the ordinary mechanisms of monetary movement simply don't work, since that money has no velocity.
As a result, Bernanke and his overseas cohorts have succeeded in saving themselves from being hindered by a surge in inflation.
The Japanese experience over the last 20 years suggests that this position, with a huge money supply and no inflation, may continue for 20 years or more.
In short, thanks to the banks, Freidman's monetary theory has simply stopped working.
Why Inflation is Headed Our Way Eventually
It's not clear to me whether at some point the banks will start lending the trillion-dollar balances at the Fed, in which case inflation will revive rapidly.
However, there is one other economic theory that is relevant here.
Austrian economists like Ludwig von Mises will tell you that ultra-low interest rates will create an orgy of speculation, in which markets create a huge volume of "malinvestment" - investment that should not economically have been made, and which has less value than its cost.
Eventually-like it did in 1929, the volume of malinvestment becomes so great that a crash occurs, in which all the bad investments have to be written off, huge losses are taken and a wave of bankruptcies sweeps across the economy.
This didn't happen in Japan. The banks went on lending to bad companies, creating a collection of zombies which sapped the vitality from the Japanese economy and has produced more than 20 years of economic stagnation.
In Japan, the politicians have even decided to print more money and do still more deficit spending. Since Japan has debt of 230% of GDP this will almost certainly produce a crisis of confidence, in which buyers stop buying Japan Government Bonds. That will cause the government to default and will more or less shut down the Japanese economy - the worst possible outcome.
Since politicians hate periods of liquidation, they could encourage the same behavior here, in which case growth will continue at current sluggish rates until the Federal deficit becomes so great that nobody will buy U.S. Treasuries.
Again, without a Treasury market, there will be an economic collapse.
At that point, you're likely to get all the inflation you want - it's basically what happened in the German Weimar Republic in 1923.
The point is, Bernanke has created something of a new monetary ground, increasing the money supply rapidly without getting inflation. But it won't last.
At some point we'll get hyperinflation and probably a Treasury default.
For investors the action to take is obvious: Buy gold. At some point fairly soon, you'll need it.
Just talking about this,
If we have hit the long term support bottom in August, there is only two options, inflation, or stagflation.
No one in the history of the world knows how to unwind this unprecedented stimulus, the world is awash in digital currency, ...
We’ve both been on FR and online forums for a long time, I’ve lost all faith in John Williams and ShadowStats. 7 years ago we would have been sitting here trying to analysis the tea leaves Williams was dropping in his free reports. No more for me.
I’d sit down and drink with the guy and bullshit about the world and how it’s falling apart, but I have seen too many impeccably written retorts to his information to giver any further credence to his body of work related to ShadowStats calculated implied rates of , UE6, M3, etc.
Because fed pumping is helping growth in Asia not in the US, better tax laws and opportunity.
I’m commenting here mainly so that smarter people than me can tell me how I’m wrong.
In my opinion, inflation is masked over the last couple of decades by a couple of things. For one, computers, internet, telecommunications, have revolutionized all kinds of things and this has helped to keep prices low and going lower.
Offshoring our manufacturing has kept prices low.
A collapsing economy has cut the price of housing.
A weak economy also affects the demand for trucking, making it lower than it would otherwise be, which helps to keep fuel lower than it otherwise would be.
High unemployment keeps wages from rising much if at all.
Thats aside from the games that the statisticians play, where they claim that something is better, hence the higher cost isn’t really a higher cost. (Similar to the games they play with unemployment figures, where if you’re out of work long enough they stop counting you). The 2% figure, I believe, is a lie.
Still, whatever is the true figure, its lower than it would be if the economy wasn’t on the rocks and we weren’t innovating, and we weren’t letting Chinese do our work for us.
Check the inflation rate of food and ammo.
And, I meant to say.
I've been giving a little more attention to articles these days that state 'when' their predictions will happen.
I'm pretty sure that TS(will)HTF...I just don't know if it's tomorrow or ten years from now. I like hearing all opinions on the 'when.'
Anyone who has bought groceries or fuel in the past 12 months knows that the “real” inflation rate is probably around 12% per year.
Just like the unemployment rate is 7.something when 8 million fewer people are employed than four years ago.
I just can’t tell if I’m reading Pravda or Tass.
4 years ago I was surprised when my shopping total went over $200 or $250 dollars.
Last week my bill topped $400 for the first time ever
We have plenty of inflation, but prices are measured in such a way as to hide the real inflation rate.
That's exactly my motivation for posting these articles.
I learn much from the questions and comments of others...often, I don't even know what question to ask. So..... (The hard part is steering clear of the Smart Alecs)
All bad news, all policy consequences of liberalism, will be hidden until they can’t be hidden anymore,
then those consequences will be blamed on the opponents of liberalism.
We’re already seeing this - the fourth quarter negative GDP is being blamed on Republicans.
Google Jonathan Cahn and listen to an interview with him to know why I say that.
Judgement 1 was Sept 11, 2001.
Judgement 2 was Sept, 2008 (economic crash).
Judgement 3 is Sept, 2015.
All on the “jubilee” 7 yr cycle.
1) High Powered Money = M = Coin and Currency = Printing Press Money.
2) Physical purchases of precious metals are not counted in any of the M numbers M1, M2, ...)
3) Since physical precious metal purchases are generally excess liquid funds (i.e.Coin and Currency) much of the increase in High Powered Money is drained by the increase in precious metal purchases.
4) Velocity of Money V is vastly impacted by loan demand.
5) While banks would love to loan out the excess Coin and Currency, industry managers are not willing to borrow money as long as an avowed socialist occupies the White House and his minions in Congress harbor the most business unfriendly sentiments seen in decades. So, as the old saying goes, "you can lead a horse to water, but you can't make him drink" regardless of the price (interest rates) of water which figuratively speaking today is ZERO.
6) Without loan demand, the money multiplier effect of High Powered Money is largely negated regardless of the increases in the other M measures.
Yes, with the BIG CAVEAT: "Ceteris Paribus", or "All things remaining equal"
But if the Velocity of money simultaneously slows dramatically, it is entirely possible for Money Supply to expand without inflation.
So, if banks don't lend the excess cash, and corporations don't spend (invest) their excess capital, what happens inflation-wise? Nothing.
But Monday's WSJ had three articles pointing to the beginning of asset bubbles: The price of Stocks, Houses and Bonds are all up.
All that cash is starting to chase things. Bubble-mania, here we go again!