Best of the Week
Most Popular
1.UK House Prices Momentum Crash Threatens Mini Bear Market 2017 - Nadeem_Walayat
2.Perfect Storm - This Fourth Turning has Over a Decade of Continuous Storms to Come - James_Quinn
3.UK House Prices Momentum Crash Warns of 2017 Bear Market - Video - Nadeem_Walayat
4.Billionaire Investors Backing A Marijuana Boom In 2017 - OilPrice_Com
5.Emerging Markets & Basic Materials Stocks Breaking Out Together - Rambus_Chartology
6.Global Currency Reserve At Risk - Jim_Willie_CB
7.Gold and Silver: Your Stomach Is Probably Wrenching Right Now - The_Gold_Report
8.Warning: The Fed Is Preparing to Crash the Financial System Again - Graham_Summers
9.Basic Materials and Commodities Analysis and Trend Forecasts - Rambus_Chartology
10.Discover Why A Major American Revolution Is Brewing - Harry_Dent
Last 7 days
North Korea Is Far From Being Irrational… It Has A Plan - 18th Aug 17
US Civil War - FUNCTIONAL ILLITERATES TRYING TO ERASE HISTORY - 18th Aug 17
Bitcoin Hits New All-Time High Over $4,400 As It Catches Paypal In Total Market Cap - 17th Aug 17
3 Psychological Ingredients behind Great Web Content - 17th Aug 17
The War on Cash - Rogoff, Orwell and Kafka - 17th Aug 17
The Stock Market Guns of August, Trade Set-Up & Removing your Rose Tinted Glasses - 16th Aug 17
Stocks, Bonds, Interest Rates, and Serbia, Camp Kotok 2017 - 16th Aug 17
U.S. Stock Market: Sunrise ... Sunset - 16th Aug 17
The Next Tech Crash Could Delay Your Retirement by a Decade - 15th Aug 17
Gold and Silver Precious Metals Nearing Breakout - 15th Aug 17
North Korea Showdown: Pivotal Market Turning Point - 15th Aug 17
Tech Stocks DOT COM Bubble Do-Over? - 14th Aug 17
Deep State Conspiracy or Chaos - 14th Aug 17
From the Trans-Atlantic Axis and the Trans-Asian Axis - 14th Aug 17
Stock Market Intermediate Correction Underway - 14th Aug 17
The Islamic State Jihadi Pivot to Asia - 13th Aug 17
Potential Pivots Upcoming for Stocks and Gold - 13th Aug 17
North Korean Chinese Proxy vs US Military Empire Trending Towards Nuclear War! - 12th Aug 17
Gold Stocks Coiled Spring - 12th Aug 17
Neil Howe: The Amazon-Walmart Rivalry Will Determine the Future of Retail - 12th Aug 17
How to Alton Towers Half Price Discount Entry 2017 and 2018, Any Time, No Pre-Booking! - 12th Aug 17
Top 3 Technical Trading Tools Part 2: Relative Strength Index (RSI) - 11th Aug 17
What Makes Women Better Investors - 11th Aug 17
Crude Oil Price Precious Metals Link in August - 11th Aug 17
Influencer Marketing Predictions All Businesses Should Take Into Account - 11th Aug 17
Really Bad Ideas - Government Debt Isn’t Actually Debt - 10th Aug 17
Gold Sees Safe Haven Gains On Trump “Fire and Fury” Threat - 9th Aug 17
Why Is The Stock Market Not Trading On Fundamentals Lately? - 9th Aug 17
USD/CAD - Can We Trust This Breakout? - 9th Aug 17
New Monthly Rebate to Help Reduce Your Trading Costs - 9th Aug 17
Stock Market Divergences Are Now Appearing! - 9th Aug 17
Is Inflation an issue or did the Fed Mess Up? - 8th Aug 17
Top 3 Technical Trading Tools Part 1: Japanese Candlesticks - 8th Aug 17
Researchers Find $10 Billion Hidden Treasure In A Dead Volcano - 8th Aug 17
What Happened to Thousands of Sheffield's Street Trees 2017 - Fellings Documentary - 8th Aug 17
Solar, Bubble, Banks, War, and Legal Tender: Five Reasons Why You Should Buy Silver Now - 7th Aug 17
CRASH - If Some People Do It, Nothing Bad Happens, But If Everyone Does It, All Hell Breaks Loose - 7th Aug 17
Gold and Silver : The Battle for Control - 7th Aug 17
Precious Metals Sector is on Major Buy Signal - 7th Aug 17
Stock Market - Has Time Run Out? - 7th Aug 17
Get Ready for an Historic Upside Gold and Silver Run - 7th Aug 17
BOOM! Bitcoin Rockets To New All-Time High As Cryptocurrencies Surge Higher! - 7th Aug 17
U.S. Dollar: This Crash Signals the End - 6th Aug 17
Predicting The Price Of Gold Is A Fool’s Game - 6th Aug 17
Asda Sales Collapse and Profits Crash! UK Retailer Sector Crisis 2017 - 6th Aug 17

Market Oracle FREE Newsletter

3 Videos + 8 Charts = Opportunities You Need to See - Free

Why There's No Real Inflation - Yet

Economics / Inflation Jan 30, 2013 - 01:16 PM GMT

By: Money_Morning

Economics

Martin Hutchinson writes: According to Milton Friedman, "inflation is always and everywhere a monetary phenomenon."

If that is true, then you have to wonder where the heck all of the inflation is.

Every central bank in the Western world is holding interest rates down, and almost all of them are printing money like it's going out of style.


Five years ago, nearly every economist in the world would have told you this would cause inflation to skyrocket, and the big deficits governments were running would make matters even worse.

Taken together, monetary and fiscal policies are far more extreme than they have ever been.

Yet, inflation has remained rather tame at 2%. In Friedman's world that just wouldn't be possible.

What does it all mean?....

It means even Nobel Prize-winning economists can get it wrong-at least in the short run.

Here's why Friedman has been wrong on inflation so far. It starts with his basic theory.

Friedman's Theory on Inflation
The central equation of Friedman's monetary theory is M*V=P*Y, where M is the money supply, Y is Gross Domestic Product, P is the price level and V is the "velocity" of money, thought of intuitively as the speed at which money moves around the economy.

In this case, the M2 money supply has been increased by 11.5% in the last two months and 8.2% in the past year, while the St. Louis Fed's Money of Zero Maturity (the nearest we can get to the old M3) has increased by 13.1% in the last two months and 8.4% in the last year.

Since GDP is increasing at barely 2%, that ought to mean prices should increase by 6%, just based on the last year's data alone.

Needless to say, that's not happening, since consumer price inflation is under 2%.

Of course, monetarists will tell you that money supply produces inflation only with a lag.

Fine, but it's also true that the M2 money supply has been increasing by 7.4% over the last five years. Admittedly, there was a year in mid-2009-2010 when it stayed flat, but otherwise the monetary base has been increasing at about 8-10% per year.

Again, growth in those five years has been below 2%, and five years is longer than anyone thinks the lag should be. So why isn't inflation at least 5% not 2%?

Monetarists would explain that by telling you that monetary velocity has declined over the last five years.

That's obvious from the equation, but what is monetary velocity and why has it declined?

The velocity of money is simply the average frequency with which a unit of money is spent in a specific period of time. And in our day-to-day activities, it's obvious that monetary velocity has in fact increased.

More people are using debit cards, which cause transactions to move instantaneously from the bank account to the merchant, and many people are using Internet banking, which similarly increases the speed of transactions, reducing both the amount of physical cash carried and the time that old-fashioned checks spend sitting in storage at the U.S. Postal Service.

So what is the problem?

Monetarists will tell you that the decline in monetary velocity is due to the massive balances, over $1 trillion, which the banks have on deposit with the Fed, which just sit there and do nothing.

That's probably correct since while the deposits exist, the ordinary mechanisms of monetary movement simply don't work, since that money has no velocity.

As a result, Bernanke and his overseas cohorts have succeeded in saving themselves from being hindered by a surge in inflation.

The Japanese experience over the last 20 years suggests that this position, with a huge money supply and no inflation, may continue for 20 years or more.

In short, thanks to the banks, Freidman's monetary theory has simply stopped working.

Why Inflation is Headed Our Way Eventually
It's not clear to me whether at some point the banks will start lending the trillion-dollar balances at the Fed, in which case inflation will revive rapidly.

However, there is one other economic theory that is relevant here.

Austrian economists like Ludwig von Mises will tell you that ultra-low interest rates will create an orgy of speculation, in which markets create a huge volume of "malinvestment" - investment that should not economically have been made, and which has less value than its cost.

Eventually-like it did in 1929, the volume of malinvestment becomes so great that a crash occurs, in which all the bad investments have to be written off, huge losses are taken and a wave of bankruptcies sweeps across the economy.

This didn't happen in Japan. The banks went on lending to bad companies, creating a collection of zombies which sapped the vitality from the Japanese economy and has produced more than 20 years of economic stagnation.

In Japan, the politicians have even decided to print more money and do still more deficit spending. Since Japan has debt of 230% of GDP this will almost certainly produce a crisis of confidence, in which buyers stop buying Japan Government Bonds. That will cause the government to default and will more or less shut down the Japanese economy - the worst possible outcome.

Since politicians hate periods of liquidation, they could encourage the same behavior here, in which case growth will continue at current sluggish rates until the Federal deficit becomes so great that nobody will buy U.S. Treasuries.

Again, without a Treasury market, there will be an economic collapse.

At that point, you're likely to get all the inflation you want - it's basically what happened in the German Weimar Republic in 1923.

The point is, Bernanke has created something of a new monetary ground, increasing the money supply rapidly without getting inflation. But it won't last.

At some point we'll get hyperinflation and probably a Treasury default.

For investors the action to take is obvious: Buy gold. At some point fairly soon, you'll need it.

Source :http://moneymorning.com/2013/01/30/why-theres-no-real-inflation-yet/

Money Morning/The Money Map Report

©2013 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2017 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife