Some Thoughts On Inflation

I often hear commentary about central banks and their “excessive” money printing. More money get’s printed, same amount of goods, inflation comes around, buy gold, protect your purchasing power. Somehow or another Zambia or the Weimar Republic are brought into the conversation. They printed lots of money, they experienced hyperinflation, so now we will. At face value, these comments all appear to make sense and I’ve generally accepted their notions. It’s interesting, given how long the printing press has been going, that there really hasn’t been a material uptick in inflation. What gives? What are we getting wrong about these theories?

What do we know:

  • the fed balance sheet has expanded ALOT.
  • Money supplies are increasing
  • but, interestingly, the money velocity is falling
  • and, inflation is benign:

So what does this mean? We are printing more money. The money that is in the system is changing hands less frequently. For some reason, inflation isn’t occurring.

I stumbled upon this very interesting tweet that talked about inflation in a way I hadn’t heard before:

I thought there were some really interesting points made by the author. To summarize:

  • The consensus is that inflation will occur because money is being printed (what we just discussed)
  • Printing, however, is just one part of the equation.
  • A dollar is “created” by banks. Banks create money by lending it out.
  • The amount they can lend out is a function of their existing collateral.
  • The tweet-storm distinguished between the collateral that the fed is creating and how this doesn’t actually make it into the economy if the banks don’t lend against it.
  • On the opposite end of the spectrum, when debts are paid it works in reverse; the money supply actually decreases
  • Banks are the interface that the central bank uses to increase the money supply. If banks don’t lend, the central bank can’t increase the money supply. This is a very important point given that excess reserves are at all-time highs. Banks aren’t lending the money that they could. Maybe this explains why the money velocity is fallng>
  • Travis highlights the recent inflationary pulse. Higher copper, gold, and other commodity prices. He likens this occurrence to a temporary surge in corporate borrowing. This makes sense. Stock up during COVID in case the worst happens. The question is, what happens when the world calms down? Does this stockpile get drawn down, pushing deflationary forces onto the world?
  • He also thinks that inflationary forces could be occurring because mandated debt payments were removed as part of COVID relief. Very interesting.
  • When people need to start paying their debt, money supply will contract and inflationary tail wind could reverse.
  • There’s also the backdrop of less lending which could also decrease the money supply.
  • If these items occur like Travis is talking about, there will be less dollars in the system which could lead to an increase in demand (and price)

Conversation in the Thread:

  • What is causing all-time-highs in stocks and real estate? It could be fear of inflation vs. the real thing.
  • Do stimulus checks increase the dollars in circulation? No. Maybe they increase the velocity though?
  • How is the Fed buying bonds not creating money? The true bottleneck to the money supply is the lending from banks, not the fed. The fed can continue to buy assets but if the banks don’t lend it doesn’t matter.
  • Great thread! What if Fed buys USTs directly from govt, that would be adding dollars to the system? Yes it would. This is the monetization that most people believe is occurring right now.
  • What about the ongoing monetization of government deficit, ie FED being buyer of treasuries – in the extreme case – FED is the only buyer – isn’t that increasing the dollar amount in circulation? NO

So the main takeaway from this thread is:

The money supply is increasing. The true money supply is based on what the banks ultimately lend out to the world. Because excess reserves are increasing, the true money supply may not be growing as much as the M2 figures would indicate. The fed’s expanding balance sheet really doesn’t influence inflation until bank reserves are reduced.

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