You hear it all the time, maybe even every day: the Fed’s never-ending quantitative easing program led by $85 billion per month in asset purchases, will eventually cause hyperinflation.
This will eventually lead to a devaluation of the dollar, skyrocketing prices for everyday goods, and death, destruction and doom of all kinds. Some very smart people subscribe to this, including many that WSO admires: Peter Schiff. Jim Rogers. Kyle Bass.
But here’s what’s probably driving them all nuts: despite no signs of letup from the Fed, inflation remains quite historically low, well within the 2% y/y benchmark sought by that institution.
I can already hear some of you starting to argue: “But headline inflation isn’t accurate! It doesn’t include food and energy prices, which are more volatile!” And you’d be right—those items are volatile, and when they spike it hurts. But the causes of that volatility are not monetary in nature—they’re geopolitical.
Do you really want the Fed to spring into action every time there’s unrest in the Middle East? Or a severe drought in the Midwest? You’d be asking Ben Bernanke to craft policy based on one sector; would that be beneficial overall? So accept headline inflation for what it is.
The reason inflation is low is not that money isn’t being printed, but because it isn’t circulating. M2 velocity (the rate at which money circulates through the economy) is at historic lows.
It isn’t circulating because so much money is parked at the Fed as excess reserves, rather than being lent to businesses and individuals. What this amounts to is a phenomenon called a flattening of the yield curve.
How do banks make money on a loan? They borrow at short-term rates (already near zero) and lend out at higher, long-term rates. Your profit is the spread between the two—your net interest margin.
If long-term rates continue to depress as a result of QE, your net interest margin shrinks, and so does your willingness to lend. No lending, no circulation. As long as it is relatively safer or more profitable to keep excess reserves at the Fed, lending will continue to suffer and the economy will not be as strong as it could be.
So, the Fed is partially responsible for holding down the economy, but probably not for the reasons you’d think.
Low inflation is good. But is this a good price to pay?
For more research and insight on this, check out marketminder.com (market analysis by Fisher Investments, one of my favorite resources): http://www.marketminder.com/a/fisher-investments-inflation-nation/4e2f1…
I stopped reading here.
He did say YoY...
RP, prank v prank is awesome lol.
Maybe if you would've kept reading, you would have learned something.
Well, the inflation factories aka central banks are now saying that the CPI is NOT a measure of inflation but rather, a measure that tracks the consumption habits of consumers.
What does this mean? If all food prices go up by 1000% except for cat food where prices only go up 2%, then they'll tell you that people will change their habits and will only eat cat food. Thus the CPI for the year will be around 2%.
And don't get me started on the way they measure the effects of inflation (one of them being rising prices).
OP doesn't even understand that. No need to read further.
Check out Bernanke's new QE printing machine:
Lenders suddenly aren't going to loosen lending standards because they can offload their shitty MBS securities to the Fed - as simple as that.
Semi-related point: hyperinflation isn't something that just happens in developed economies. It generally requires a very unusual combination of factors:
Printing money may cause inflation creep, but historically has never caused anything really extreme.
The United States has been at war for over a decade now. Yes, the way we are funding this war is vastly different from Germany in WWI. However, with no real end in sight and our continuing overseas military presence, do you not believe this will lead to higher rates of inflation in the long term?
I think I didn't make my point clearly. The issue for Germany was not the spending on the war, but the supply shock: some of the most productive German land (Alsace-Lorraine) was occupied and held by France after WWI. The supply shock plus the reparations payments imposed on Germany created the perfect breeding grounds for hyperinflation.
Also, I agree that government spending in certain circumstances can prove inflationary. If the government were to maintain its deficits once the economy no longer has much unused capacity (which is not at all the case now, nor likely in the near future), the result would be an overheating and inflationary economy. However, a true hyperinflation, in which billion dollar bills are printed and the real economy is left in shambles by the chaos, would not occur simply because of an overheating economy.
Hyperinflation is not caused through the normal processes of inflating and deflating the money supply. It is the result of the loss of confidence in a currency, as a consequence of a generally high inflationary environment that can manifest itself for a number of reasons.
See Latin America in the 70s-80s.
The Latin American countries that experienced hyperinflation were all subject to the 3 conditions I outlined above.
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