Sunday, March 27, 2011

Neither Inflationst Nor Deflationist Should Thou Be (In the short-term)

I get many emails that begin something like this:
Because you are in the inflationist camp.
I get an equal number that start along these lines this:
Because you are in the deflationist camp.
Please know that at present, I am in neither camp. Although in the long-term I fully expect the Federal Reserve to launch operations that will result in huge amounts of new money entering the system, a move that will ultimately become very price inflationary, it is not clear at all that this will occur in the short run.

Although the Federal Reserve is currently pumping huge amounts of money into the system, most of that money is finding itself back at the Fed as excess reserve, and therefore back out of the system.

In late 2010, three month money supply (M2) growth peaked at just above 7% on annualized basis, since then it has dropped back to between 4% to 5%.

This is typical of monetary policy under Fed Chairman Bernanke. Money supply growth has been a bronc ride. I have literally been tracking money supply growth week after week, with pen and paper, for decades. I have never ever seen such wild swings in money growth as the swings under Bernanke.

This is partly because of the many new monetary "tools" that he has introduced by which he conducts monetary policy. Since the old tools of the Fed: controlling the discount rate, the reserve requirement and controlling open market operations, worked for the Fed chairmen before Bernanke, it is unclear why Bernanke created the new tools. Further, it is unclear as to how controllable the new tools are, e.g. since Bernanke started paying interest on excess reserves, the amount placed by bankers in excess reserves has swelled to over a trillion dollars. It is unclear that Bernanke has created the proper new "tools" necessary to battle the new tool of paying interest on excess reserves, should bankers suddenly decided to start loaning that money out.

I follow the changes in money supply, excess reserves, required reserves, etc, weekly in the EPJ Daily Alert. Money supply really has to be watched that closely at this time. The longer term money growth trends in the days gone by of Alan Greenspan and Paul Volcker are a thing of the past.

It is extremely dangerous, at present, to be bold and step out and say that inflation or deflation is imminent. If the current annualized money growth trends of between 4% and 5% continue, I fully expect stagflation, i.e., price inflation but a stagnant economy. If money growth climbs back over 7%, price inflation will be much stronger (well into the double-digit range), with a manipulated stronger economy. If money supply growth dips below current levels, the economy could move into crash mode.

All this said, the exact direction on a short-term basis is unclear because of the whipsaw action of monetary policy under Bernanke. It is too dangerous to be a hardcore inflationist or deflationsit at present for the short-term (meaning roughly for the next year or so). It is simply best to watch the money growth numbers and adjust investments accordingly.


  1. While I seriously enjoy your work - totally disagree with this.

    This is one issue you can't afford to get wrong, one issue you can't get protection for after the fact.

    Mark my words: It'll come like a thief in the night.

  2. If the money is not entering the system, then what is propping up he stock market?

  3. Davos--
    You disagree with the article, so which side are you on?

  4. @Disinter

    As I pointed out, M2 money supply growth was at 7% on an annual basis. Since it is lower now, you have the potential for a downward spike, if it does not start climbing soon.

  5. I believe hyperinflation brought about by a collapse of the currency.

    I specifically do not agree with this: Please know that at present, I am in neither camp.

  6. So... you agree with it, then, since the author predicts hyperinflation in the long run.

  7. Inquisitor: And if it happens tomorrow?

    Every currency crisis I've read about happens in hours. They build like ours has been building and then they snap.

    I wrote a piece on this.

    I did a chart on it, in Weimar gold went from 3,900 to 30,000. "If" that happens today - how many people will be able to afford 1 ounce? How many people will be able to stock on on enough food to get them through a year?