Don’t Be Fooled: Inflation Has The Upper Hand

Don’t Be Fooled: Inflation Has The Upper Hand

Wednesday, December 8, 2010

Executive Summary

• Money supply (M2) has been steadily growing for a decade, and banks hold an unprecedented amount of excess reserves that could enter the market at any time.
• Credit growth is flatlining.
• Debt in the household & financial sectors (the big enchilada) exhibits the deflationary trends that are pre-occupying the Fed.
• Federal government credit is exploding upwards as a result.
• Corporate and state debt are increasing, but at more moderate rates.
• Energy costs are high and getting higher = inflationary.
• Confidence in paper currencies is plummeting = potentially hyperinflationary.
• Forecast for the future…

Part I

If you have not yet read Part I of this report, please click here to read it first.

Part II 

In Part I, we stepped through prices as useful indicators of whether we are in a period of inflation or deflation.  Because there’s no more important determination to make than to get an early read on whether we are facing a future of inflation or deflation, we are going to dive a bit more deeply into the evidence here to round out the story.

Let’s begin with….

Money

The classic definition of inflation or deflation is a “relative change in the amount of money compared to goods and services.”  Too much money and you have inflation; too little and you have deflation.

The story here is pretty simple.  The broadest measure of money that we have, M2,* has been growing in a virtually uninterrupted fashion since 1995. 

*From the St. Louis Fed:  M2 includes a broader set of financial assets held principally by households. M2 consists of M1 plus: (1) savings deposits (which include money market deposit accounts, or MMDAs); (2) small-denomination time deposits (time deposits in amounts of less than $100,000); and (3) balances in retail money market mutual funds (MMMFs).  MZM is M2 less small-denomination time deposits plus institutional money funds. 

The simple truth is that M2 has been growing in a very steady fashion for quite a while.  There was a bit of exuberance in 2009 that caused its growth to flatten out for a while, but it’s heading back up again. 

When we look at MZM (“Money of Zero Maturity”), which factors out time deposits (principally bank CDs) to give us a view of what people and companies can most readily spend, the story is a bit murkier.  Money slid during the last half of 2009 and the first half of 2010 but has since rebounded and hit new highs. 

We might say that MZM supported a tale of deflation for almost a year, especially during the first half of 2010, but that story has since been negated.