THE EXPLODING U.S. MONEY SUPPLY MYTH….

In recent weeks some hyperinflationists have succumbed to the reality that QE2 isn’t really adding net new financial assets to the private sector – it is indeed just an asset swap.  But this hasn’t stopped them from claiming that QE2 directly results in an exploding money supply.  This convoluted thinking claims that QE is directly funding government spending (as if the US government would have stopped spending money and folded up shop without QE2).  So now the theory is that QE is really resulting in excess of $1.5T in new money in the form of deficit spending. This is flawed for reasons I have previously explained, but let’s not theorize about the money supply – let’s allow the facts to speak for themselves.

Over the years many have been quick to cite the monetary base as the direct transmission mechanism that would lead to the great hyperinflation.  We all know the story – the Fed’s balance sheet explodes, the monetary base shoots higher and money starts flowing out of bank vaults like a volcanic overflow.  But regular readers are all too aware that the monetary base has no correlation with the broader money supply.  The reasoning is simple – the money multiplier is a myth.  So, it doesn’t matter how many apples (reserves) the Fed puts on the shelves.  It doesn’t result in more apple sales (loans).  Banks are never reserve constrained.  The explosion in reserves and continuing decline in loans makes this crystal clear.  The Fed can continue to stuff banks with reserves and unless we see a substantive increase in lending the expansion of the monetary base will continue to be insignificant.

But what about M2?  Isn’t it also exploding higher now?  Not really.  In a recent article Erwan Mahe, an asset allocation and options strategist with OTCexgroup, posted this excellent chart comparing M2 growth across the big three economies.  He said:

“As you can see in this graph, China literally allowed its money supply to skyrocket, compared to that of the U.S. or the eurozone, with annual growth averaging +17.4% between 1996 and 2008, which compares to +7.1% in the eurozone and +6.3% in the United States.

Above all, since the beginning of 2009, this divergence has actually widened, despite the Fed’s QEs and 0% interest rates, since Chinese M2 has been growing at 26.6% per annum (!), versus +3.5% in the U.S. and +2.3% in the eurozone.

So, I wonder, is Bernanke truly responsible for the hike in world commodity prices and the ensuing popular upheavals?”

The story here couldn’t be more self explanatory.  The US M2 money supply is simply not expanding anywhere close to its historical rate.  The only country where the M2 money supply is seeing any sort of substantive growth is in China.  And so it’s not surprising to see the combination of commodity hungry China and enormous money supply growth result in higher commodity prices.  While I don’t think it’s incorrect to blame some speculative aspect of this rally on the Fed it is entirely incorrect to blame the Fed for the commodity rally due to their “money printing”.  The fact is, the USA is not expanding the money supply at an alarming rate.  China controls their own money supply.  If they desire to print money in order to maintain their flawed currency peg then that’s a policy only they can control.  Blaming the Fed for China’s flawed monetary policy is not even remotely fair.

Although the USA stopped issuing M3 we can still measure M3 through various independent sources.  Hyperinflationists are often quick to point out Shadow Stats when anyone cites the CPI.  Ironically, according to their data the M3 money supply is still shrinking at an annualized rate:

So yes, the US government is running a massive $1.5T deficit, however, by any metric of money supply we can see that this is barely offsetting the continued de-leveraging that is occurring across the US economy.  We are certain to see higher rates of inflation in 2011 (especially if oil prices surge higher), however, it is not an accurate portrayal of reality to conclude that the USA is “printing money” uncontrollably and flooding the world with dollars that will lead to hyperinflation. That is simply not the case and the data speaks for itself.  At best, we are barely printing enough to offset the destruction of de-leveraging….

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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Comments

  1. Cullen, are you saying that when the asset swap takes place the banks absolutely don’t buy shares or speculate on commodities with the QE money? If there is lttle or no fractional reserve lending surely they wouldn’t be satisfied just earning interest on the increased reserve balance. It was canvassed last week from your “Mystery Buyer” article comments that QE11 may have something to do with attempts to move the fth utures market higher while everyone slept. Is it happening again before Mar 8th, 2011 session??

    • Banks aren’t doing anything that they couldn’t have done before QE. If they are more eager to bid up risk assets now then that’s their choice. I’ve never denied the fact that Fed policy makes investors act in irrational ways. But QE isn’t giving them any “firepower” to do anything that they couldn’t have done before QE….

      • Cullen,

        Everyone who makes your argument focuses on the entire monetized amount, and I agree with you about the asset swap argument that limits its impact. But I’ve never read anyone addressing the play money on the edges…….the inflated profit on the treasury round trips, the commissions generated on the monotization round trips, the gifted interest on the reserves held back at the fed, and likely more I’m unaware of.

        If you sum up this gifted money, together with the very clear wink and nod from the fed that we will not allow you to fail, wouldn’t this amount aggressively supporting the bid be impactful?

        The fed itself said it plans to inflate assets to prices the fundamentals don’t warrant. And we know they can’t control where all their gifted cash flows to….they want it in equities but it can certainly also flow to commodities as well…..how can you state so confidently the commodity ramps aren’t substantially due to the fed? Thanks, krb

        • Ok, we’re not far apart. I just think (purely anecdotal on my part I know) that with trade volumes drying up, these small amounts of money, “small” by economy standards but not by low-volume market standards, in institutional hands ARE able to move markets…..I’m not talking moving economies, I’m talking about moving markets. The fed itself has said asset prices don’t reflect the economy……they want the MSM to report and the sheep to believe it reflects the economy, but their stated strategy is that prices will be higher than the economic fundamentals warrant. Thanks, krb

          • Well, banks can always move markets. If JPM wants the Dow to go up 1,000 points tomorrow I am sure they could do it. On the whole, QE is doing little if anything to contribute any new “fuel” to the banks. My argument with regards to QE has always been about the real economy. I’ve never said that Fed policy doesn’t highly influence markets. In fact, I’ve always said the opposite.

            The point I am trying to get across is that QE is not our economic savior. It might help boost nominal asset prices (higher than they otherwise would be), but that’s about all it does. If that translates into some sort of huge confidence boost and “virtuous cycle” then we’ve found a new path to economic prosperity – ever higher nominal prices! Surely that can’t come back to haunt us can it? Oh wait, I forgot about 1999 and 2008. And Hong Kong 2008. And the South Sea bubble. And the tulip bulb mania. And the Nikkei. The list goes on. Nominal wealth creation is not self perpetuating….In fact, you could argue that there is nothing more destructive than nominal wealth distortions….

            • Agreed. Unfortunately, I believe this artificial market levitation is their entire strategy. The amount of interest rate sensitive derivative exposure still outstanding at the banks would still bury them. They have to state that their strategy is “sustainable economic growth and employment”, but they have access to the derivative exposure numbers. Short of dissolving all the large money center banks, they know the best they can do is try to just buy themselves more and more time to continue chipping away at the interest rate derivative exposure.

              This also links to my point from yesterday that we shouldn’t accept the “well it would have been worse if we hadn’t done it” argument. First, that argument conveniently is completely unprovable, and second, while it might have been worse for wall street, it is quite arguable whether or not it would have been worse for the other 90% of America. What is the price to the other 90% of a decade or more of this malaise, while we pursue our strategy of artificial bank and market levitation? Thanks, krb

              • krb,

                I fully embrace your point that if there were a depression it would have been brief, thus the bailouts were wrong. The prudent and savers could have invested in assets at really attractive prices w/o the need of leverage.

                But Cullen has a blockade in his mind to see it this way.

                InvestorX

        • Cullen:

          I enjoy your site and find it informative.

          My question for you is: If the Fed continues QE2 with a QE3, will you begin to change your view on potential future inflation? Why or why not?

          Thanks.

          • Given your position, are you buying US 30 yr Bonds?

            If not, what are your recommendations for investments given the current economic environment?

      • Nonsense. They are swapping ‘dead money’ T-bills for cold hard cash. So, of course they can speculate with the cash, whereas they couldn’t with the T-bills.

        • Dead money? What was stopping the bank from selling the bond before and buying anything it wanted to? That’s right. Nothing. They might be more inclined to replace the lost income from the t-bill, but the bank doesn’t have some new fuel that they didn’t have before. What this is saying is a lot like saying that when you buy stocks you have lost your ability to make purchases. Of course that’s not true. Not only can you use your stocks as collateral to buy other assets, but you can easily sell these stocks and purchase anything you want. In markets as liquid as the UST market that’s never a problem….

          • TPC,
            Don’t bother – you are arging with someone that started shorting the SPX at 1050 and hasn’t stopped shorting since. I’m sure that “Gary_UK” is just broke and pissed-off

      • Thank you for the post. I have recently discovered your website and your observations on how the American economy operates. Obviously, it is quite different than convential economic wisdom, and to what I learned in school.

        Under your theory (i.e. that a government with a monopoly supply of currency in a floating exchange rate system has no solvency risk), wouldn’t the model society be:

        -extremely high marginal tax rates (creates the required “demand” for the currency and thus avoids debasing it),
        -perpetually high level of government spending, including large deficit-spending, (creates more currency and gets it into the hands of the citizenry)

        Also, if all currency is spent into existence and must be “credited” to the private sector prior to it being collected via taxes, wouldn’t it be impossible to run a government surplus for any extended period of time w/o throwing the economy into a deflationary spiral?

        Does your theory hold that government spending crowds out private sector investment? If so, then it indicates that a balance must be struck between government spending too much and crowding out productive capacity and government cutting back and risking a deflationary event. The third choice: decreasing spending and greatly decreasing taxes risks devaluing the currency. How does the government determine how to strike the correct balance in this system. I apologize if this has all been answered elsewhere. I am simply trying to wrap my mind around this concept. Thanks again.

        • Also, if all currency is spent into existence and must be “credited” to the private sector prior to it being collected via taxes, wouldn’t it be impossible to run a government surplus for any extended period of time w/o throwing the economy into a deflationary spiral?

          Absolutely correct. In fact, every period of surpluses in US history was promptly followed by a recession. Clinton’s surpluses were not really and exception since the recession that started was promptly nipped in the bud by Bush’s tax cuts (without him even realizing it at the time.)

          Does your theory hold that government spending crowds out private sector investment?

          It depends what is the mechanism of crowding out. The government takes resources from the private sector and is able to do so by imposing a tax liability, which allows it to buy anything in the economy with its currency. It is of course possible to divert resources from the private sector to the govt sector to the detriment of the economy. But this is a political issue first of all. “For any given size of government there is a level of taxation that is consistent with full employment” (Warren Mosler). Spending itself does not cause it. MMT sees government spending as a necessary condition for the non-govt sector to save net financial assets (NFAs). If the govt injects more NFAs than the non-govt sector desires to save then you get inflation. Not enough – you get recessions.

    • From a bank perspective (and many institutional investor), having cash or TBill is practically the same. Either they use cash, either they used t bill as collateral (with very low to null haircut) to borrow cash.

    • Variations on this question always amuse me, since we are often discussing the fact that banks are holding massive reserves. If they were using them to buy speculative assetys the reserves wouldn’t be there.

      • Wrong. The only asset purchase that can drain reserves is to purchase Tsy’s or something off the Fed’s balance sheet. Otherwise, any purchase just moves reserves from one bank to another, and doesn’t change the total.

  2. How long do the hyperinflationists have to be wrong before they just shut up and go away?

    • The problem with most hyperinflationists is that they are blinded by politics. They ignore facts because they are blinded by their dogmatic view that govt is always ruining their lives. So, they will conjure stories about the Fed at any cost. It makes for better politics if you can convince everyone that the Fed is funding the spending and therefore printing money and causing all this horrid inflation everywhere. And this is all coming from a guy who hates the Fed more than just about anyone….Trust me, I’d love to be able to blame everything on the Fed. But facts are facts.

      The anti govt story doesn’t sound nearly as great when you uncover the actual facts and recognize that the US govt isn’t actually flooding the world with money and that China is the real cause here….

      Plus, as long as gold and commodities rally (mainly due to China) they will continue to have an argument to fall back on….Correlation and causation. Oh well. It would be nice if people could at least eliminate their politics from this all….

      • Hi Cullen.

        I guess my question would be if the Fed’s qe program isn’t doing anything that the banks couldn’t have done without it..the money from the qe programs aren’t flooding the markets and causing any type of inflation…what excatly is the purpose of the qe program? Thanks in advance and I agree with you 5000%-we would be a much better world without the Fed. G-

    • “How long do the hyperinflationists have to be wrong before they just shut up and go away?”

      No, the question is, does it even matter?

      Bottom line: US money base tripled in 10 years while dollar is trading record low against most currencies. and you know how much you need to fill the tank.

      Either an ivory tower economist or random internet junkie can post an article on internet to judge who is right and who is wrong. But again, does it matter? who cares? even you are right how do you make money out of it? I have a buddy turned 10s of thousands to millions by doing nothing but shorting dollar. But I haven’t seen anyone who can make a living betting against currency depreciation.

  3. Thanks Cullen. Another “hyperinflation myth” well explained. China’s money supply growth is indeed scary. But China’s empty buildings, unsold real estate projects, underpaid and exploited workers, enourmous private project debt levels, asset speculations, … are even more scarier. Some common sense tells me that this can not possibly end well. Economist Andie Xie is rather optimistic and tells us China has indeed some problems to face but immediatly adds that they are temporarly and small to the great potentials for growth in China. I have a hard time believing this will just end as a small bump in the road for China. What are your thoughts?

    • As usual, will there is a productivity collapse? Will te demand for their goods produced will collapse? will the poors become even poorer? Is there not enough people to fill those empty houses? Is the government strong enough to “fill” those building by force? Is the enormous private debt not easier paid with inflation?…

    • This a 1000x. If you believe in a hyper inflationary collapse in the US, you gotta believe that will happen in China, Vietnam or Japan first, considering their policies. It just drives me nuts the amount of people that say that take the US money supply and say this is proof that the US is about to go Zimbabwe, and then totally ignore the Chinese money supply growth and say that China will be the next superpower of the world.

  4. Great “story of the day”, as always!

    What has caused the explosion of China’s money supply over the past 10-15 years? Leveraging to invest, the currency peg, or deficit spending? Or combination of these three and other elements?

    And for that matter, how does the currency peg actually work?

    Correct me if I am wrong here (I probably am), but I believe Walmart pays its suppliers in USD. Since those suppliers must pay expenses in Yuan, the suppliers demand Yuan and are willing to supply USD, pushing the Yuan/USD up. Since a constant exchange rate is desired, the Chinese central bank sets the price, and lets the quantity of USD it buys determine itself. Is this correct?

  5. Very good Cullen. Typically, these hyperinflationists have come a long way intellectually and have great resources at their fingertips; so it astounds me that they get it soo wrong! I think that they’re right to have misgivings about the Fed, but to fear hyperinflation is to give up the good way of thinking that got them skeptical in the first place..

    • From your blog – ” Professional economists & government officials did not think that a fall in the mark had anything to do with increasing the national debt (printing paper marks). Furthermore, they deemed increasing the national debt as an absolute necessity. These things together created the vicious cycle that you mention: Printing money caused a fall in the external value of the mark, which was deemed to necessitate further printing of money. They had to give up that idea in order to restore a functioning currency (and hence economy).”

      Is this not what the Fed is enabling the US government to do when the Fed buys up the Treasuries from the Primary Dealers? It would seem that the Fed, in buying Treasuries barely weeks after their issue, is enabling the government to issue ever increasing amounts of debt at artificially low interests rates. It seems to me that the only thing preventing the rapid fall in value of the dollar is the never ending printing of currency and debt by all other nations. Ours just might be the prettiest horse at the glue factory, but it is still going to end up as glue.

      • Ah, you got that from the comments; I encourage you to read the article to understand the context (if you haven’t already).

        The rapidity and dynamism witnessed during the inflation in the Weimar Republic was the product of a dogmatic idea: that a fall in the external value of the mark necessitated further discounting of treasury bills at the Reichsbank (at above market prices!). So – insofar as this idea remained legitimate – ‘money printing’ necessitated more ‘money printing’ almost immediately; for market participants would consistently try to find a profit-motive in owning the paper mark, while the government fought that with dogmatic ferocity.

        The Fed buys existing debt of the US Government, but it is true that the US Government might not be able to issue great quantities without the Fed. If the intentions for the supplementary financing account were to change slightly, then we could have a structure more comparable to the Weimar Republic.

        However, the important point to note is that today’s exercises in balance sheet expansions lack the dynamism of the Weimar Republic. Furthermore, the ‘money printing’ idea lacks the widespread legitimacy that its German counterpart had (e.g. think about the uproar against the Fed? How many people are worried about inflation?). Today’s balance sheet expansions are designed to alter the composition and structure of the dollar so that socially systemic institutions will survive. This – in itself – does not immediately necessitate further money printing (as the printing of paper marks did). Rather it is an outright redistribution of capital that allows certain institutions to survive. This is why I reject the prospect of hyperinflation..

        • I did indeed read the article and found it interesting. After having read ‘When Money Dies” I came to the conclusion that it is precisely because of the ready availability of information in today’s world that hyperinflation is more, not less likely, to hit the US. The speed at which information travels makes it far more likely that hyperinflation can hit with speed that would dwarf that which hit Germany in the 20′s. I believe we have more than enough dollars around the globe to cause the US to experience hyperinflation should confidence in the dollar collapse worldwide and all those dollars find their way home. My $.02. Good day to you and yours.

  6. I quite agree with your analysis on QE2. It will not create inflation until the net credit (private/public) starts growing again. But we should not forget rising comodities prices which basically come from investors trying to protect their money. Those rising prices will surely create inflation if not reversed soon. Of course is a type of inflations that can not be fought with monetary tools, but inflatios after all.

  7. The reason for commodities prices increase has little to do with money supply. Rather it is the expectation that the Fed will have to keep monetary policy loose for an extended period of time, so any improvement of economic outlook and rising in inflation expectation drive stocks, oil, food, and others, because no people in their right mind will think that the Fed will raise interest rates in the near future.

    How Does Ben Bernanke Screw Up The World?

  8. Good article. I think the point can be hammered home by citing one other fact. The Fed is paying a higher rate of interest on reserves (0.25%) than the going rate on t-bills. In other words, it costs more for the government to “print” money than it does to borrow it! So how can Fed “printing” be funding anything?

  9. Cullen, thanks for the M2 graph. I had no idea Chinese M2 expanded that much over the years. Makes you really wonder where things are headed over there.

    We have over the last 50 years enjoyed setting prices for the rest of the world in many commodities and other goods. I keep thinking that we are going through a massive transition where we begin to import inflation from the growing EMs. This is something we are not used to at all and I think most people in our country assume prices will drop back down since demand is stagnate here.

    One aspect I continue to think about is the continued deterioration of the middle class balance sheet and how higher raw materials will eat away at disposable income. This seems like a majoy story this year. I’m not sure how to correct this, but something has to change. People cannot contiue to see their bills explode higher with stagnate wages.

  10. Dear Sir,

    As the saying goes, “a watched pot never boils”.

    As for inflation, just because the pump is primed (with money) doesn’t mean that inflation will strike instantly. …and stock market bubbles always extend for far longer than anticipated.

    Yet in both situations, the results do occur.

    Let’s chat again about this topic in 24 months, okay?

    Then we may be in a better position to which of us is more likely to be correct about the inflationary impact of The Fed’s QE program.

    • Yes, and mark my word it will be rationalized some how with a new name that Bernanke and is alchemist will create.

      • Dir Sir,

        Just because we are sitting in the bottom of the economic trough doesn’t prove you are correct. The effects of The Fed’s QE policy will not be felt until the economy truly begins to rebound. I believe we are only now beginning to see the start of an economic rebound.

        I have also spoken to several economists who feel that once the economy turns upwards in earnest, The Fed will be faced with a very serious situation due to the loose money policy (QE & QE2) it has created. One economist likened The Fed’s future soft-landing challenge to: “Landing a 747 on an Aircraft Carrier”. One only needs to look at the charts on this to see the cliff in front of the USA.

        “Chart of The US Money Supply 1917-2009″
        http://www.chartingstocks.net/2009/03/chart-of-the-us-money-supply-1917-2009/

        • Correction… The economist likened The Fed’s soft-landing challenge to:

          “Landing a 747 from 60,000 feet onto an Aircraft Carrier flight deck.”

  11. “The problem with most hyperinflationists is that they are blinded by politics. They ignore facts because they are blinded by their dogmatic view that govt is always ruining their lives.”

    And then there are the deflationists who tell us that the issuance of bonds by the federal gov’t is a LIQUIDITY DRAIN, but when the fed takes out the bonds they tell us that NOTHING HAS HAPPENED.

    Maybe they’re just blinded by politics.

  12. Picking on the hyperinflationists is easy. I agree, it unlikely to happen – just as a default is unlikely to happen.

    But why not mention the Dollar carry trade’s effect on China? Both China and the US are currency manipulators no? Isn’t that what central banking is all about?

  13. Inflation is more money. But that is not how the gov’t tells it. They tell us that if more money is created and it goes into bonds, that’s deflation. But if more money is created and it goes into hard assets, that’s inflation.

    Well, more money has been created and, simultaneously, the fed has taken the bonds off the market and replaced them with liquidity that pays less than the rate of inflation. Hence, the money flows into hard assets and out of bonds and it creates inflation. Thus, the fed is DIRECTLY RESPONSIBLE for the increase in prices of hard assets, which is known as inflation.

    Mithos. Aren’t you the guy on elitetrader that has never heard a conspiracy theory about George Bush that you didn’t buy into lock stock and barrel?

  14. Hey yo,

    Yes, I visit e-trader, which conspiracy theory is that one? That’s giving GWB a lot of credit, you know?

    LOL

    I’m a political and economic agnostic. Both parties are pointless. I guess I should step up my Obama criticisms to sound more balanced. But I gave up on both parties after watching Obama’s Hope and Change Campaign Promises fizzle…

  15. The velocity of money counts as well as the money supply.It appears to me that although the velocity of money in the economy is declining it is increasing in certain markets.James Hamilton’s rather good article on the Velocity of Federal Reserve deposits would appear to knock holes in that theory but its only part of the story.

    http://www.econbrowser.com/archives/2011/03/velocity_of_fed.html

    We know that equity turnover is down, flows in mutual funds are down, the amount of short cover is down, whilst in contrast flows in emerging markets and commodities is up. This suggests to me a reduction in velocity in one part of the market and an increase in another. The reason for this would appear to be comovment of global equities, the search for yield, the size of certain markets and ultimately QE2 through keeping interest rates low and driving the search for yield.The bank of Japan in their financial market report has a good discussion on some of the drivers.

    http://www.boj.or.jp/en/research/brp/fmr/data/fmr110228a.pdf

    The change in velocity of money in different parts of the market has different multiplier affects on inflation in my view.Its not hyperinflationary or an expansion of money supply, just an imbalance which could create the right conditions for hyperinflation (namely currency volatility) in the future.

    • @brick

      great post by hamilton that you referred to. also great money velocity chart.

      my question is what happens to treasury rates when the fed tries to drain the trillions in excess reserves and reverses qe by becoming a net seller of treasuries. i’m thinking that long term rates will increase. perhaps markedly as the treasury continues to sell a boatload of debt to finance the deficit and finds that not only is the fed not buying, it is now selling. china has recently been a net seller of treasuries.

      of course the fed could bump up the .25% rate it pays on reserves, but if long term rates increase, banks may prefer the risk/reward of lending long as opposed to investing short with the fed. then you will see the money velocity graph reverse. the fed may have to chase after itself to keep reserves on the shelf.

      either way, i see both long term and short term rates trending higher in the 6-24 month period.

  16. TPC,
    Can you help me understand this:

    “China controls their own money supply. If they desire to print money in order to maintain their flawed currency peg then that’s a policy only they can control”

    My understanding is that China maintains its peg essentially by fiat (makes it illegal to trade at any other rate) rather than by buying and selling its own currency.

    That being the case, how does maintaining 25% money supply growth help them maintain the peg?

    I strongly agree that commodity inflation and indirectly dollar weakness has been more a product of China’s monetary and fiscal policies than ours. I equate China’s fiscal stimulus as an indirect means of flooding the world with dollars because of their ability to maintain the peg.

    • It is against the law in China for a person, business or bank to hold US dollars. All US dollars in China eventually are handed over to the Chinese Central Bank in exchaneg for Yuan. Because the central bank refuses to do anything with its US Dollars other then to sit on them (buy US treasuries) the only way they can keep trading Yuan for Dollars is to print more Yuan. As long as that is there policy they can’t control their money supply – its dictated to them by the peg and flow of dollars.

  17. “The problem with most hyperinflationists is that they are blinded by politics. They ignore facts because they are blinded by their dogmatic view that govt is always ruining their lives.”

    I don’t think “most” hyperinflationists are blinded by politics. Geogrge Soros is not know to be a right wing ideologue but he has cautioned about the fact that future inflation is likely.

    Just as we can’t accurately forecast exactly when and how much the consumer will spend or when he will stop spending, we can’t exactly forecast when and by how much households will borrow. For both forecasts we can use history, culture and rational analysis to build an estimate but is has been a long time since we have gone through such a sustained deleveraging period.

    When households end deleveraging, the money supply will start to grow again. It will start quicker then central policy makers are able to react. They will need to guess the start time but may guess too soon or too late. They will also have to drain a HUGH amount of liquidity in order to reign in money supply growth. The resulting recession may be just a painful as our original economic collapse but the Federal government will have a much more debt owed to the public.

    Personally, I think household deleveraging is unlikely to end as long as real estate prices continue to fall.

    The commodity prices increases are a result of the Asian dollar peg. China has implied they are addicted to the peg and risk social unrest if they unwind it. They also need an 8 – 10% annual growth just to maintain stability. Their economic model will be put to the test with higher oil prices on top of already high inflation.

  18. Good article! Another myth exposed. If we add to the deleveraging effect the high unemployment and also the fact that 10% of the population controls 80% of the wealth, inflation is not even a remote possibility.

    Could you respond to this Bill Gross type who is screaming everyday that the end of the world is coming? What is his problem?

  19. Cullen would offer that Bill Gross – the dominant bond investor of our time – does not understand that bonds don’t fund the u.S. government.

    • Right. The good thing about Bill Gross is that he gives us all hope. With a little timing, above average intelligence and a little luck we can all become billionaires!!!!

      • Cullen you seem like a very intelligent person, your timing, judging by your algos results seems excellent…so where are you billions? Are you just unlucky? ;)

  20. In this posting you are purposefully arguing the wrong thing in an attempt to distract or mislead your readers from the real source of the problem. See the truth here -
    http://www.zerohedge.com/article/primary-dealers-flip-53-just-issued-7-year-bond-back-fed-under-two-weeks
    It’s not about “how many apples the Fed puts on the shelf.” It’s about the Too Big Too Fail banksters borrowing money at 0% interest to buy Treasuries and then sell them to the Fed just a few weeks later at a profit. THIS IS THE REAL STORY: We are creating massive debt that is being forced onto current and future generations, while the banksters are getting rich off of us.
    This is the opposite of a bank robbery. What we have going on is the banksters are the ones who are taking from the people and leaving them with a huge debt burden that will have to be repaid in the future.
    And, this is just the beginning. You see, this purposeful destruction of the American economy has been engineered for decades by the globalists who seek a one world government. Because, once the economies of the world crash for real this time they will be waiting in the wings with a proposed solution…one they’ve had ready for many years. They will attempt to usher in global governance and a global banker who will offer solutions to this nightmare. And, in exchange they only ask that nation’s give up their sovereinty and right to self-rule (see Greece, Ireland, Portugal and soon Spain, Italy, etc.) And, they will usher in a new global currency that will better allow them to rule over the world.
    Here’s another wonderful website that helps tell you what’s really going on in our world -
    http://www.theyenguy.wordpress.com
    Welcome to life as a debt slave…thanks to the global banks.

    • Poke your head around the site and you’ll quickly find that I am more pissed off about the banks and their actions than just about anyone. That doesn’t mean I am going to start fabricating lies about monetary policy just so I can back up a political agenda….

  21. I strongly recommend anyone who really wants to understand the effect of QE2, Reserves, etc. on inflation and asset/commodity prices to read what Hussman has been writing.

    MC

  22. The author of this article says, “We are certain to see higher rates of inflation in 2011 (especially if oil prices surge higher)”

    But aren’t oil prices surging higher be a symptom–not a cause–of inflation?

    I thought inflation results from an increase in the money supply.

    And that a rise in the price of a commodity from a growing scarcity of that commodity, is not inflation.

    Does the author understand what he is talking about–or am I misinformed?

    • The rise in price is two-fold. Part of it is due to supply and demand and part of it is due to inflation (the debasement of the value of the US Dollar).

      However, the original meaning of term “inflation” was defined as the later; namely – when the government increased the money supply to pay for things it did not have hard currency (real value) to cover.

      Inflation is always the evil temptation of governments that want to buy more things than they can afford from taxation or real value creation. When the US Dollar was fixed (pegged) to gold (the “gold standard”) the government could not expand the money supply unless it had an equivalent backing of gold in Fort Knox to back up the paper it was putting out into the economy.

      If you ever looked at a “gold certificate” or “silver certificate” paper dollar it had written on it “redeemable for (gold or silver)”. This provided confidence in the early paper currency with the country’s citizens and with foreign trade partners.

      Historically, it was when war came along that the government would vote to remove itself from the “gold standard” in order to pay for the weapons of war. Once off the gold standard, the government was free to “inflate” the currency unhindered.

      Inflating the currency without increasing the “real value of the economy” to an equal level equates to the government stealing some of the value of every man and women’s currency holdings to pay for things the government cannot afford. It is an evil and hidden taxation on the citizens of this nation. Most people do not realize this is actually what is happening.

  23. The article is correct, but totally revellent to nothing. In 3- years, we will have hyperinflation, but not because of the reasons discussed in the article. Inflation will begin when our government debt exceeds GDP. And will be out of control in 3-5 years. There is no known answer to our deficit spending. If you balance the budget, you will put 100s of thousands of people out of work. A good start would be to change the constitution and abolish the Unted Sates House of Representatives.

  24. Money supply yes its still low, but “If we add to the deleveraging effect the high unemployment and also the fact that 10% of the population controls 80% of the wealth,” No

    Venezuela as all those characteristics and a inflation rate of 29.3%

    • Mr. Rahn says he’d like to balance the budget. So, he’d like to run at most a 0% deficit in essence. Does he have any idea what that would do to pvt sector savings? It would crush it. It would cause consumers to re-leverage, result in more pvt sector debt and drive us into certain recession. This man has no idea how a modern monetary system functions. He is oblivious to reserve accounting and sectoral balances.

      It’s embarrassing to even write such things in such a prominent newspaper. The sad thing is, most people read his political bull shit and eat it up as if it is gospel. They know nothing about the things they discuss….

        • Ha! Someone push your button??

          Too much Debt? Is a trillion too little, a dozen too much? As a controls engineer, I have had to strike a happy medium many times, and I don’t mean punch a drunken palm reader. What is the right amount of debt??

          • Absolute numbers don’t matter. What matters is the economic realities. You know it’s too little when you have 20% un- and under-employment. You know it’s too much when you have 0 unemployment and demand-pull inflation.

            • Peter is absolutely correct. Thanks for shining the light of knowledge into the darkness of the uninformed.

          • Yes, Mr. Rahn pushes my buttons when he clouds economics with political pandering. It’s BS and it’s ruining this country. So yes, it pisses me off and I am getting tired of people who mix their politics with economics. There’s no place for it.

  25. Cullen:
    If balancing the budget would be so detrimental to our economic future, what does that tell you about about our economic present?
    Don Levit

    • Don, nice to see you here. Looks like you cannot give up on MMT, huh?
      The only one that needs to balance the budget is the private sector. The govt balancing the budget would necessarily – as a matter of accounting identity – drive the private sector into debt, at least as long as we have trade deficit. Just as a bowling alley needs to “deficit-spend” points in order for you to be able to score a strike.

      • Right on! That’s what I crave (a feedback indicator) I wonder what Dr. Bernanke has been looking for? There are rumors that he will possibly hold off on QE3 for a short while. Maybe he’s getting pressure from China, but with a 1.5 to 3 yr Lag Time (also a control engineering term) Inflation should continue up for another 1.5 to 3 years.

      • Sorry Peter D,

        clicked on wrong post above El Viejo meant for your reply immediately above.

        • No problem.
          Yes, feedback indicator. In facts, MMT seeks to even make that automatic. If you have enough automatic stabilizers in place, then the deficits will grow and shrink on their own depending on the “road conditions”. It already happens to some extent – thanks to transfer payments we have a minimal level of budget deficit to support aggregate demand.

          • Now you see why my attraction to MMT. It feels right, and yes I still doubt, but like I said on my post on debtdeflation.com mentioned in my reply to @First (several posts above) wrestling “manual” control away from politicians seems almost hopeless especially when you add in the demands of the ignorant masses for a balanced budget. I think most reasonable people expect some debt though. To me it’s just common sense diversity of operation. (firing on all cylinders or using all tools) However, right now I wonder about the possiblity of false numbers of Federal employees (and a big govt handicap) I’ve been told the numbers of contractors working for the govt is huge and not represented well in factual figures.

              • Interesting site. Just the right amount of (justified) paranoia. Like I said in my debtdeflation.com reply to @First several posts above. The biggest chunk of change in the arsenal is the tax base, so whatever affects it would seem to have the biggest affect on the economy. I really didn’t mean to imply that we should bring back the 90% tax bracket in its entirety, but some adjustment is called for. I think just like Long Term Capital Mgmt in the 90′s was having an affect on world markets too much money in play now through 401k’s and the billions of the rich and famous are causing problems. I think we are headed for a second dip just like 1929.

  26. Unfortunately thats the way it presently works, the money of the private sector comes via the deficit not the fed. The Fed is a tool. Its like saying even if you don’t let us to spend and grow more than we take or produce you really have no choice since the economy will be cut of the oxygen it needs to function.

    There are limitations to such a systems and that is what history will most likely teach us.

  27. TPC thanks for the article.
    so why is USD so trashed compared to other currency right now? all due to speculation? your opinion is highly appreciated.

    • The main driver is relative weakness due to int rate policy. Keep in mind that Europe is now very seriously talking about rate increases. The Fed is nowhere close to that stage. So, it’s driving the USD down on a relative basis.

  28. Peter D:
    The trade deficit affecting the private sector – is that more of a political
    problem than an economic one?
    Are you saying the private sector should be supported by the amount of the trade deficit?
    What about the debts of the private sector itself?
    Is there a role for government to play there?
    Would the debts that states are accumulating have another, albeit different, role for the federal government?
    According to popular belief, the states are not supposed to run deficits.
    Is that a bunch of propaganda, according to MMT?
    Don Levit

    • Don, to save time, I suggest you read the following introductory posts:
      http://www.creditwritedowns.com/2011/02/government-deficits-and-the-financial-sectors-balances.html
      http://heteconomist.com/?p=1902
      In short, the definition of govt deficit is the accounting offset of non-government sector’s surplus and trade deficit. As long as you have both of the latter positive, you just have to have the govt deficit.
      To unwind debt in the private sector you’d have to have either write it down or allow the sector to de-leverage in an orderly manner by stepping in and filling the output gap, so, yes, by running an even bigger deficit in the short term (hopefully, since once the economy returns to full employment the deficit will automatically shrink.)
      US States are currency users and as such they should really be counted among non-government sector in the sectoral balances identity. So, yes, they need to run balanced budgets, although they can still act countercyclically to some extent by increasing their deficits and issuing bonds.
      The trade deficit is affecting the private sector, but it is not really a result of government spending, despite the “twin deficits” hypothesis. In other words, even if not a single dollar was spent on Social Security, Medicare, defense, unemployment benefits, salaries of congressmen etc, the fact that we import more than we export makes the foreigners holders of US dollars.

          • Peter & TPC,

            Great answers. Thanks. What is the cause of the trade deficit? Can it be fixed? Should it be fixed?

            • I will defer to TCP as my knowledge here is very limited. But from what I know the main reason for the trade deficit as large as it is is the reserve currency status of $US. In other words, the foreigners are really keen on holding $US and are willing to trade their real output for it. The trade deficit has its costs such as jobs moving overseas (although one may counter that we’re now in the stages of development where we don’t really want that kind of jobs. (Another cost is the fuel to deficit terrorists and people who cannot sleep at night thinking that Chinese will stop giving us $US :) ) But overall we’re getting something for nothing, so to speak, so, looks like a benefit to us, unless we get too addicted and stop producing anything. Everything is good in moderation, I guess.

            • Complex question with many moving parts. Yes, foreign desire to net save in USD’s is the main driver. The corollary is that there is low savings in the USA.