Monday, January 26, 2009

Right, Like That's Not Going to Cause Inflation

The beautiful and illustrious Kate sent me this chart this morning;

It shows the monetary base (the actual cash money supply) skyrocketing up as idiots in Washington think somehow printing more money will save this economy.

But to get a real feel for how much money is being printed you have to compare it to GDP, the amounts of goods and services we're producing;

Typically, the monetary base as a percent of GDP has hovered around 6% during times or relative peace and absence of war or Great Depressions. However, many thanks to the sub prime dead beats, socialist housing policies, nepotism and cronyism in the incompetent financial sector, as well as simple greedy bankers, the monetary base has effectively doubled in just months to over 12% GDP.

Now, I know this is ignoring other measures of the money supply such as M2, M3, and the long abandoned L, but this chart provides an excellent explanation as to how inflation occurs and why you just can't print off more money. The reason why is it juxtaposes the two main factors that determine inflation;

1. The supply of money (Monetary Base)
2. How much stuff we're producing (GDP)

Understand that money has no value in itself. It is just worthless coinage or paper. The only real reason money has value is that something can be bought with it. So for example, you can print off a trillion dollars for every person in America, but without a proportionate increase in the amount of X-Boxes, cars, food, clothing, housing, etc., "stuff" nobody is any richer. Ergo, all you do in printing money is increasing the amount of money to buy the same amount of goods (GDP, or as I like to call it "stuff"). Therefore, you have more money per unit of "stuff" which is the definition of inflation.

Now, as I said before, it is a little more complicated when you factor in things such as other money supply measures, but not much. The founding principle stays the same;

If you print off more money without a corresponding increase in the amount of stuff (GDP) you produce you will have inflation.

Get ready for the 70's all over again folks. It's what you pay for when you believe in hope and change and flowers and Skittles and free lunches and clouds and fairies and unicorns social security.


Anonymous said...

I don't feel that is necessarily the case.

The bulk of credit destruction is yet to occur.

The shell game of suspending mark-to-market has yet to come.

What would be interesting is to compare this expansion of money with the defaults experienced so far.

Additionally, I think that at best, this infusion of cash (Which I TOTALLY OPPOSE, just so ya know), will be anti-deflationary.

In order to get back to the apparent liquidity levels of two years ago, all the leverage would need to return, along with all the consumer borrowing, and stocks would have to gain a lot back.

We already hit peak leverage. It ain't gonna come back.

The amount of MONEY being printed can't hold a candle to the amount of debt that is NOT being re-created as it is destroyed.

Additionally, much of the Fed's infusion will eventually need to be unwound, which will dampen inflationary pressures.

Get ready for more deflation.

Jay Currie said...

I had the top graph over at my place with much the same inflationary conclusion - a really huge inflation.

Of course the deflation folk maintain that will not happen because the bad bank debt and the hedgies algos are sending $ to money Heaven at a pace sufficient to actually reduce the money supply. It is a sort of wealth evaporation theory.

My own sense is that a good deal of this "money" going to money Heaven was and is an artifact of the algos and never had any existence in the real economy whereas the crisp hundreds coming off the presses for Ben's helicopters is all too real and will be chasing a shrinking pool of goods all too soon.

Anonymous said...

Paul writes,

I thought under a scientific elite, management of money would be free of politics, steady and strong.

You know, something about the Federal Reserve Act as opposed to the old days with all sorts of swings, crashes, panics.

So, am I right in thinking that the Fed is yes again another centralization of power and another bureaucracy that doesn't fix what it was supposed to fix?

Unknown said...

I think it can only chase goods (i.e. cause inflation) if manufacturing is at capacity and people are bidding up the price of finite goods. As long as demand is down and commodity prices stay low, I can't see this as being inflationary in the near-term. It does, however, do vicious things to the national debt. That crisis is over the horizon, i.e. after eight years, so why would any politician care?

Evil Sandmich said...

I think the deflationary people are of the thought that people can afford less in a bad economy and thus drives down prices, and as Uncle Ben's actions worsen the economy that prices will continue to be driven down until products start disappearing from the shelf as there's no longer the liquidity to sustain them.

I'm real rough on understanding this stuff, but I'm of the understanding that he's driven that car about as far it'll go without risking some horrible damage to the economy. Unfortunately Washington seems more than willing to help keep pushing in the same direction.

sean foley said...

I think Jay Currie is right.

Where can someone put his money to protect himself form inflation?

Anonymous said...

I am very surprised to see the Monetary Base expanding during the Great Depression. I thought that Friedman and Schwartz found out that it contracted heavily (they probably measured M2 or M3).

So it looks like it's Great Depression all over again today. The Fed expands the Monetary Base but it cannot prevent M2/M3 from falling, which causes deflation.

Just as a reminder for all our junior economists out there: The Fed does print money, but it has no means to give it to the people. Thus they need private banks (the so-called "monetary transmission channel") lending the fresh printed money to the people.

However, The Fed cannot give orders to private banks that they start lending again, at least not yet (hopefully this will never happen).

In my opinion, it's hard to tell whether we will have deflation, inflation, or neither of them. Let's wait and see how many banks go bust and if the government can bring up enough money to socialize all banks, if they do fail.

Anonymous said...

I know this isn't right, but here's how my simplistic mind looks at it: The number of dollars in circulation has gone up 70% since October, my paycheck is the same size, so that dollar in my wallet is now only worth 59 cents. My slice of the pie is now much smaller.

Anonymous said...


You are making a mistake in your interpretation of the graphs. The nominal money supply was flat, but because GDP collapsed, as a % of GDP, the money supply grew.

Also, sure the Fed can't force banks to lend, but it can offer to lend money to them at 0%, which it is doing. So if someone offered 0% to you, you would turn around and invest it (lend it) out.

Anonymous said...

you cannot protect yourself against inflation as long as the government is increasing the money supply.

Anonymous said...

you cannot protect yourself against inflation as long as the government is increasing the money supply.

Sure you can - TIPS

Treasury Inflation Protected Securities.

Google it.

Anonymous said...

You can avoid inflation by converting your cash into actual assets; preferably ones that will depreciate slower than the dollar. Things like computers or ice cream. :)

I'm still pissed that the Fed stopped tracking M3. Those bastards.

Anonymous said...

You are making a mistake in your interpretation of the graphs. The nominal money supply was flat, but because GDP collapsed, as a % of GDP, the money supply grew.

Of course you're right. I didn't realize that. However, it doesn't really change what I said thereafter. The monetary base as a percentage of GDP increased massively and they still got some 20-30% deflation during the Great Depression. It means that there were three possible reasons for deflation: 1) The Money Multiplier collapsed, thereby preventing M2/M3 from increasing like the monetary base, 2) money velocity collapsed, or 3) money demand increased (due to less trust in banks and deflationary asset prices).

I suppose those three things could happen again in 2009, especially the first and second point. The Fed lends money to banks at 0%, but many banks are technically insolvent, so they save everything they can get.

Anonymous said...

I think the really interesting part is that the commercial banks are blocking the increase in the monetary base to affect the wider economy by refusing to lend it out (keeping it at the FED). So regardless of our interpretation of the future, one thing is for sure - if that monetary base did flow into the market through some good 'ol fractional reserve banking (like the gov't wants it too) there would be hell-a-inflation.

In short : The government is screaming at the commercial banks to start inflating the dollar like they are supposed to.

Be aware of "fake rebounds" though, if one were to occur and the banks got their confidence back and started a rally lending out the new funds, the game would definitively be over. Luckily it seems, no one actually wants to lend anymore money, since people are beginning to realize that everyone is actually broke. Long ago.

Evil Sandmich said...

Also, sure the Fed can't force banks to lend, but it can offer to lend money to them at 0%, which it is doing. So if someone offered 0% to you, you would turn around and invest it (lend it) out.

Such as, I dunno, lending it back to the government. Borrow from the Fed at 0% and then lend it to Congress at 1%-2% via treasuries, score!

Unknown said...

As a bank, even if the fed is giving you money at 0% interest, you still have to pay it back someday. So the banks must still make sure that whoever they lend to are credit worthy, and in this bad recession, there aren't many good borrowers. So it is easy to see how money may not be making it out to the real economy.

Anonymous said...

Regarding the Monetary Base:

The Monetary base doesn't indicate money in peoples bank account, it indicates money printed by the Fed. M2 indicates the money in peoples bank accounts. It has been growing by about 10%/year since the start of the crisis.

Only if the Monetary base expands M2 down the road will you get inflation. That hasn't been determined yet. Its dependent on all of the banking parameters everyone is talking about.

Regarding the values of the Great Depression:

During the depression, M2 collapsed, but the monetary base did not. When M2 collapsed, the economy collapsed with it, and became a much smaller multiplier of the monetary base.

If the Monetary base had not grown in the last 3 months like it has, M2 probably would have collapsed, and a second great depression would have started.

Pick you poison:

1) Rocketing Monetary Base with possible inflation down the road.

2) Collapsing credit, collapsing M2 and another Great Depression.

And no, you don't get a third choice.


Hot Sam said...

preferably ones that will depreciate slower than the dollar. Things like computers or ice cream.

Freaking hilarious, Ryan!

Right now, I'm tapping away at a 1GH laptop I bought for nearly $3000 in 2001. All I need now is some ice cream and I'm all set!

How about Obama promises? They depreciate before the words have reached the ears of the listener.

Anonymous said...

Glad you liked it, Robert. The increases in the money supply make finding assets that depreciate more slowly than the dollar a pretty easy task. I'd be wary of inflation-protected treasuries, though. If half of the government debt were inflation-protected, it just means they'll need to print more money to cover all their debts. I'd imagine that it increases the chance of them defaulting, as well.

"You are making a mistake in your interpretation of the graphs. The nominal money supply was flat, but because GDP collapsed, as a % of GDP, the money supply grew."

GDP would have to drop by half for the nominal money supply relative to GDP to increase from 6% to 12% on that alone. A 5% decline in GDP would increase the nominal money supply as a percentage of GDP to 6.315%. There's something else at work here. Printing presses, by my guess.

Actually, the whole issue about goods depreciating got me thinking; the reason that a computer is worth less than it was a year ago is because there's newer, better stuff out there. My computer performs the exact same function that it used to, exactly as efficiently as it used to. Hell, I've got a laptop that's more than 10 years old (Woooo, Win95!) and the only thing that's dead is the battery. I'd be willing to bet that some of the depreciation in car values is due to the same sort of thing.

Anonymous said...

As a Wannabe economist, but a competent historian, I have to ask.

If what you say is true, why is the graph going DOWN in the 1970s?

I remember the 70s. My Dad was a government employee and he got 3% and 4% raises in an era of 7% and 9% and 12% inflation. We stopped going to the Elks Club, stopped eating out, stopped eating steak, started eating Hamburger Helper, stopped buying new cars, stopped taking trips.

There was serious inflation in the 70s. But your graph would indicate there wasn't.

What's up?

Anonymous said...

Larry, the graph only shows currency. The total money supply is more than just the amount of cash floating around, and it's not just the amount of cash that drives prices. Here's a chart showing the size and composition of the money supply back through the 60s.

You'll notice that while cash and M1 declined as a share of the total money supply in the 70s, M2 and M3 growth more than made up for it.

There's also the matter of who is holding the cash that determines the effect on prices. The following chart shows that during the 70s and 80s cash was a higher percentage of household financial assets than at any other point during the past half century.

So, there was less cash and more households holding cash than before or since. It's a little odd, but definitely shows that it's not just the amount of cash that drives inflation. This is one of the main reasons I'm pissed at the Fed for not tracking M3 any more; it's like they're trying to cover up the evidence that they're not the inflation-fighters that they pretend to be by abandoning the most comprehensive measure of the money supply. Note that M3 more than doubled in the half-dozen years or so before they decided to stop tracking it.


how did the fed inflate money before 1972 when the gold standard was abolished? was inflation due to more gold in circulation due to mining, or did they just claim to have more gold than they did?